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Expert Commentary: Inventory Draws Should Tighten Oil Markets Soon

Oil rig

- Oil traders saw more of the same this week with range bound flat price, strong brent and WTI spreads, weak gasoline spreads and option implied volatility at multi year lows. In terms of physical trading flows we also saw more impact from OPEC supply cuts as US crude exports increased by 200k bpd w/w to 1.2m bpd with trading groups moving American crude to Asia and Lat Am, US crude imports decreased to 7.3m bpd (lower by 2m bpd over the last two weeks) as OPEC allocations to US customers have been cut and mid-east tanker rates dropped on decreased OPEC demand for floating storage and shipments. The market has responded to this bullish progress by pushing deferred WTI and Brent spreads comfortably into backwardation while hedge funds have built record high net length positions in NYMEX WTI and ICE Brent.

- While OPEC is making progress on reorganizing trade flows and moving time spreads into backwardation, two factors persist in keeping current rallies in check and moderating the potential for longer term flat price strength. In the near term, gasoline stocks in NY Harbor and Amsterdam-Rotterdam-Antwerp remain extremely bloated. Despite this week’s modest inventory draw gasoline stocks in the US mid Atlantic are higher y/y by 15% over the last four weeks. Gasoline stocks in ARA currently stand at a small y/y deficit, but are +24% y/y against their 5yr average. The oversupply continues to put pressure on RBOB structure with the m1-m2 spread trading 22 cents contango this week. On a longer horizon activity from US and Canadian producers continues to exceed expectations and dampen the prospects of longer term oil market strength. In the US, COT data shows producer/merchants holding their largest gross short position since 2007 at more than 750k contracts, the rig count is over 600 for the first time in 16 months and production is now over 9m bpd for the first time in 20 months. Further north, Canadian production has jumped from 3.7m bpd in October to 4m bpd in January and rigs have increased from 52 in December to 194 as of last week.

- Looking forward we still expect WTI to move into a $56-$61 range in the near term as high levels of compliance with OPEC cuts accelerate US inventory draws in 2Q. We also expect to see some US-lead demand improvement in the coming months thinking gasoline consumption will reconnect with broadly positive US economic data. Despite their weekly volatility (which has shown some curiously bearish prints) on a YTD basis US refiner inputs are +1% y/y, gasoline consumption is flat y/y and distillate demand is +5% y/y.

Gasoline, crude oil spreads tell different stories

WTI spreads moved sharply higher this week with help from Cushing’s largest draw (1.5m bbls) since October. Heightened exports and decreased imports helped bring stocks in the hub to their lowest since November and WTI J17/K17 matched its highest print since October at -26 for a 50-cent rally over the last 6 weeks. Gasoline spreads, however, continued to trend negatively with H17/J17 trading 22 cents contango due to the glut of product in New York harbor. In diff markets OPEC cuts and news related to the WH border tax plan helped push the M17 arb lower -2.00.

 

Not all product spreads trended negatively this week, however, and in Europe the prompt 1-month gasoil spread traded -2.25 on Friday to maintain a $1.25/t rally over the last month. Gasoil inventories in the ARA hub are bullishly -11% y/y. Prompt brent spreads were highly erratic with H17/J17 trading up to -5 cents for a 15-month high aggressive selling in cash markets and profit taking from trade groups sent the spread back to -35. Dated vs. Frontline Brent traded similarly corrected lower moving from a 6-month high of -46 on Wednesday to -71 on Friday. Related: Gasoline Glut Remains The Biggest Red Flag For Oil Markets

US producer data continued to strengthen this week beginning with a modest increase in output to over 9m bpd for this first time since April ’16. Production has increased more than 550k bpd since its low in July ’16 and the gains don’t appear to be at risk with producer/merchant gross shorts at a 10yr high of 756k contracts while the US rig count has jumped to a 16 month high at 597 and has nearly doubled since its low in May ’16. In option markets we saw more producer hedging in Cal ’18 on the $50 line this week for modest size.

US producers still feeling the OPEC love

Option values descend into the gutter

The pain continued for option owners this week with implied vol for WTI J17 moving down to just 24% which was justified by a drop in realized volatility to 18.5%. The drop in both metrics has them printing at their lowest levels since 2014 with implied vol lower by about 4 vols on the month while realized vol is about lower by about 10 vols on the month. In terms of trading flows vol arb players have been content to wait for some sort of realized vol justification to begin buying options again rather than attempt to bottom-pick at the currently low levels.

Funds resume buying spree, cut short positions

Hedge funds were net buyers of NYMEX WTI and ICE Brent last week for the fourth time in the last five weeks. In NYMEX WTI funds were buyers of 12k contracts and also cut short positions by about 30% resulting in a net buy effort of 31k contracts. In ICE Brent funds also bought 12k contracts while selling 16k contracts. Combined net length between the two contracts has more than doubled since November jumping from 417k to more than 870k.

COT data for refined products was less exciting last week and showed a modest increase in RBOB net length while net length in Heating Oil fell by about 9%. In ETF flows the USO saw net selling of $85 million for the week ended February 17th and has seen net outflows of $140 million YTD. 

EIA data takes bullish turn

• This week’s stats showed a much smaller than expected build in crude oil stocks while gasoline and distillates showed much larger than expected draws

• Moderating PADD III imports and elevated exports helped generate a 1.5m bbl draw in Cushing

US crude stocks increased by 564k bbls w/w bring overall stocks to a 9% y/y surplus. PADD I inventories fell by 242k bbls and are +2% y/y, PADD II inventories added 73k bbls w.w and are flat y/y while PADD III stocks are higher y/y by 17% following a 887k bbl weekly build. Trade flows were critical to this week’s stronger than expected data beginning with record high crude exports of 1.2m bpd while imports dropped by 1.2m bpd. Together the two factors helped create a Cushing draw of 1.5m bbls which brought stocks in the hub to their lowest level since November at 63m bbls.

(Click to enlarge)

US refiner inputs fell sharply w/w and for mid February are at their lowest y/y level since 2014. Over the last four weeks inputs have averaged 15.6m bpd which is lower y/y by 0.1%. PADD I inputs continue to be the regional laggard with demand in the region -4% y/y. Refining margins were mixed this week with the WTI 321 crack moving to $17/bbl while RBOB/Brent for east coast refiners moved slightly lower to $17/bbl. In Europe, gasoil/brent yielded $11/bbl. Related: Statoil Sues Researcher For Allegedly Stealing Secret Frack Tech

Refined product data was the true leader of this week’s EIA report beginning with a surprisingly bullish 2.6m bbl draw in gasoline stocks. Overall US gasoline stocks are now flat y/y but stocks in PADD IB remains +15% y/y despite a modest w/w draw in the region. PADD II inventories are flat y/y while PADD III stocks are lower y/y by 1%. Domestic gasoline demand and exports continued to look erratic with a sharp w/w jump and are flat y/y YTD in 2017.  

Distillate data was also surprisingly strong beginning with a 4.9m bbl draw. Overall distillate stocks are higher y/y by 2.7% over the last four weeks and PADD IB stocks remain bearishly high at a +7% y/y surplus. PADD II stocks are +4.5% y/y following a 295k bbl build this week and PADD III stocks are lower y/y by nearly 2% following a 2.1m bbl draw. Domestic distillate demand jumped sharply higher w/w bringing exports + domestic consumption to +5% y/y YTD for 2017.

Meanwhile product data in Europe and Asia continues to look tight to us and re, ARA gasoil stocks fell by 117k mt w/w and are lower y/y by 11% over the last four weeks. Fuel oil stocks in the ARA hub had a modest w/w increase but look bullish at a y/y deficit of more than 30%. Further east, distillate inventories in Singapore jumped by nearly 2m bbls w/w but are lower y/y by 1%.

By SCS Commodities Corp.

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