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Beware Of Supply Risks When The Whole World Is Bearish

- WTI traded in a $44-$47 range this week lifted by a 7.6m bbl US inventory draw and positive demand data in Europe and China. On the upside production gains from the US and OPEC members kept rallies in check.

- The most damning bearish force in the market continues to be unexpected supply strength in Canada, the US, Libya and Nigeria. This week US production printed 9.397m bpd (20-month high) cooling the reaction to an otherwise strong EIA report. Overseas, OPEC’s June data added a chill to the market as Bloomberg estimated Nigeria output at 1.75m bpd (16-month high) and Libyan output at 840k bpd (32-month high.) Overall group production was estimated at 32.55m bpd representing a 260k bpd m/m increase with help from a 90k bpd increase in Saudi Arabia. Libya and Nigeria will attend the OPEC + Russia meeting on July 24th but Kuwaiti leadership commented earlier today that it would be premature to ask them to cap output at current levels. OPEC compliance fell below 80% for the first time this year fueling concerns that the group will fail to deepen the current supply cut deal.

- The most important upside risk to us at the moment is that sentiment has become so one-sidedly negative. This week the IEA lamented the nonexistent market rebalance in 2Q while Goldman Sachs commented that oil could fall below $40 (their 3-month WTI base case is $47.50) without a bullish catalyst such as a ‘shock and awe’ OPEC cut or stress signals from US producers such as a falling rig count. The USO experienced its largest w/w outflow since December last week ($358 million) and fund positioning is still massively bearish including an all-time net negative position in refined products. When every participant has written off the possibility of a rally (even Andy Hall!) and the market is pricing in 0% supply risk it could be time to consider that sentiment is just way too pessimistic.

- We also think the market is taking relentless output increases from the US, Canada, Libya and Nigeria as a matter of fact at a time when US producers are coming under stress and MENA tensions are rising. Given the market’s intensely negative sentiment we think that it would be wise to remind ourselves that oil prices and supply risks generally enjoy an inverse relationship and the market has lived without a supply shock for abnormally long period. Increased potential for supply stress alongside overwhelmingly bearish market sentiment is, in our judgment, an upside risk to be carefully monitored. Wood Mackenzie recently released a report estimating that Permian breakevens have increased to $43/bbl (and on a path towards $45/bbl) and the Eurasia Group downgraded their supply forecast for Nigeria on increased political risk. Related: Significant Draw In Crude Inventories Jolts Oil Prices

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Saudis help push WTI spreads + arbs higher

In the last 4-5 weeks Saudi Arabia has worked hard to publicize export reductions to USGC customers and recent import data suggests that the cuts are beginning to have an impact on US crude oil supplies. PADD III crude imports printed 2.7m bpd last week and are lower by 16% y/y after falling by more than 900k bpd over the last three months. So far the reduction in USGC imports has been an effective counterweight to the flood of Canadian crude still arriving in the Chicago area and the result has been a prompt 1-mo. WTI spread near -16 cents while Z17 WTI-Brent has jumped to -2.40.

US crude production has screamed higher over the last two weeks erasing briefly held optimism from bulls that low prices were slowing the uptrend in output. US producers pumped 9.4m bpd last week for an increase of 969k bpd from last summer’s low and are within 215k bpd of their all time high print in June of 2015. US crude rigs increased to 765 and are higher YTD by 44% but hedging activity has slowed significantly as flat price has weakened. As of July 4th merchants and producers held a combined gross short on NYMEX WTI + ICE Brent of 1.85m contracts representing a 14% decrease since March.

Brent spreads also climbed higher this week despite increased OPEC production with help from improved European demand and Chinese imports which are +14% y/y YTD. The recent jump in demand has helped draw floating stocks from 209m bbls to 185m bbls over the last two weeks (although ARA crude stocks have moved slightly higher.) The prompt 1-month brent spread indicates reasonably strong fundamentals at 25 cent contango while DFL Brent moved higher to -80 cents.

Option values rot on expected sideways trading

Options markets were generally slow this week as flat price steadied and hedging activity was limited. We have also noticed a lack of upside risk buying from funds and trade groups as hopes of a summer bull run in crude oil have diminished. In the front of the curve WTI U17 at the money vol sold off from 31% to 29% over the course of the week and maintained its shift to a more bearish skew from last week’s trading. In the back of the curve vols were steady with WTI M18 ATM vol near 30% and 25d puts trading at a 6-vol premium to 25d calls. Related: Is Wall Street Funding A Shale Failure?

Options markets were generally slow this week as flat price steadied and hedging activity was limited. We have also noticed a lack of upside risk buying from funds and trade groups as hopes of a summer bull run in crude oil have diminished. In the front of the curve WTI U17 at the money vol sold off from 31% to 29% over the course of the week and maintained its shift to a more bearish skew from last week’s trading. In the back of the curve vols were steady with WTI M18 ATM vol near 30% and 25d puts trading at a 6-vol premium to 25d calls.

ETF flows show retail giving up on crude

Last week’s COT data showed a small net buy effort from hedge funds lead by short covering. Combined net length between NYMEX WTI and ICE BRENT increased 14% w/w by 47k contracts as gross short positions were reduced by 26k contracts. Fund net length is currently 49% below its 1yr average while gross shorts are 70% above their 1yr average.

Spec positioning in refined products continues to be negative with funds holding a net short of 10k contracts in gasoline and a net short of 51k contracts in heating oil. ETF flows also revealed harshly bearish sentiment in the oil market as the USO experienced a net flow of $358 million- its largest outflow since December.

EIAs finally deliver the bullish goods

• Wednesday’s stats showed better than expected draws in crude oil, Cushing stocks and gasoline supplies. The headline supply and demand data showed the type of numbers that bulls had been anticipating for weeks, but likely showed up too late to generate any enthusiasm for crude oil from the long side

• Refiner and gasoline demand also strengthened to the type of levels that bulls had been waiting for in May in and June

• On the bearish side, US crude production maintained its w/w progress and continues to pour water on rallies

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US crude supplies fell 7.6m bbls w/w lead by a 2.5m bbl draw in PADD II, a 6m bbl decline in PADD III and a 1.9mn bbls draw in Cushing. Overall US crude oil inventories are now +1% y/y and +3% in PADD II and +0.5% y/y in PADD III. PADD I inventories are flat y/y. The large w/w overall crude draw was created by strong refiner demand while exports moved higher to 918k bpd and imports dropped to 7.6m bpd (-3% y/y.) PADD II imports continue to look bearish printing 2.5m bpd last week (+13% y/y) while PADD III imports are now -16% y/y.

US refiner demand continued to serve as one of the few bullish inputs underpinning the crude market printing 17.25m bpd for a 103k bpd w/w increase. Overall inputs are higher y/y by 3% over the last month with a 2.5% increase in PADD I, a 4.6% increase in PADD II and a 4.9% increase in PADD III. The demand outlook continues to look to us through the balance of 2017 due to continued strength in refining margins in the US and abroad. Gasoil/brent has look particularly strong moving from $8/bbl in early June to $10.80/bbl this week.

US gasoline supplies also tightened more than expected on a sharp drawdown in USGC supplies helped by exports and elevated refiner runs. Overall stocks fell 1.6m bbls with PADD I and PADD II stocks flat w/w while PADD II stocks fell 1.7m bbls. Overall gasoline supplies are now lower y/y by 1.8% over the last four weeks while PADD IB inventories are lower by 8.6%. PADD II inventories are +1.5% y/y while PADD III stocks are +2% y/y. Gasoline exports printed 547k bpd last week and are +38% y/y while domestic demand printed 9.8m bpd and is +1.2% y/y.

US distillate data was more bearish than expected with an overall stock build of 3m bbls. PADD IB stocks added 1.8m bbls due to an uptick in imports into NYH and are lower y/y by 2% while PADD II stocks jumped 2m bbls to a 13% y/y surplus and PADD III inventories fell by 1.8m bbls (flat y/y.) Domestic distillate demand continues to highlight the complex printing 3.9m bpd last week for a 20% y/y increase over the last month. Exports came in at 1.2m bpd last week and are lower y/y by 10%.

Bonus Charts

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By SCS Commodities Corp.

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