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Expert Commentary: Volatility Vanishes In The Oil Markets

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• WTI submitted a new YTD high of $51.67 this week, albeit in exceptionally boring fashion. In the ten trading days ending June 6th WTI traded in a $2.81 range - its most narrow 10-day range since June 2014. Oil option premiums have been obliterated as a result with implied volatility dropping to 30 percent while realized volatility sank below 20 percent for the first time since October 2014. We still don’t like owning crude options for directional bets or being long-volatility at the moment despite newly depressed prices, but we expect that to change later this summer.

• Away from the oil market, central bank-fueled rallies in the EUR/USD, sovereign debt and equities were broadly supportive for crude. Macro strength was driven by last Friday’s exceptionally weak U.S. jobs data, Chair Yellen’s perceivably dovish speech on Monday and the ECB’s commencement of corporate bond buying for its current balance sheet expansion effort. As of Thursday afternoon Fed funds futures suggested 2 percent odds of a June hike and 23 percent odds of a July hike. S&Ps came within 0.07 percent of their all-time high on Wednesday.

• Continued outages in Nigeria and Canada also helped lift oil. At the moment, we see these issues continuing to drive oil market sentiment and believe that the current rally may have some room left. On a longer horizon, however, we plan on owning U16 or V16 maturity put spreads as higher prices should shift supply discussion towards U.S. producer ‘green shoots’ (the oil rig count is now higher over the last four weeks,) core OPEC producers keep pumping at Ludicrous Speed and Canadian wildfires dissipate. Bearish refined product issues also persist as evidenced by recent weakness in HO and gasoil spreads while RBOB spreads have completely collapsed on a flood of PADD I imports. Lastly, we expect at least some degree of mean reversion in the USD to be bearish for oil as last week’s jobs data was much more likely an exception than a new trend of sub 50k/mo U.S. job growth. The Fed remains eager to hike rates and any possibility of a July hike should keep the EUR/USD somewhat in check.

Prompt spreads buckle despite supply issues

WTI spread markets were weak in the front of the curve and strong in Cal 17 this week while maintaining a focus on Canada’s production outages. The EIA expects the wildfires to disrupt output to the tune of 400k bpd in June after taking more than 1m bpd off the market in May. In the U.S., Baker Hughes reported on June 3 the largest w/w increase in U.S. oil rigs (+9) since December. The rig count has enjoyed a net increase over the last four weeks for the first time since August of last year, which has led some commentators to suggest that it may have bottomed. The most recent data included an addition of five rigs in the Permian basin.

While the ‘flattening’ of U.S. rigs won’t bring U.S. production back above 9 million bpd anytime soon, the threat of ‘green shoots’ in the U.S. supply picture could have a key psychological impact on the market in similar fashion to how the market behaved after inventories peaked this spring without overflowing storage tanks. U.S. crude production also registered its largest w/w gain since December this week of 10k bpd, but most of the increase was due to Alaskan output and not frackers in the shale plays of interest to WTI spread traders. In its Short Term Energy Outlook released this week the EIA predicted a global crude oversupply of 800k bpd in 2Q and 3Q.

Prompt WTI spreads were technically weak and traded below -0.60 on Thursday for the first time since April 7th. Further back in the curve things looked much stronger with WTI Z16/Z17 rallying to -0.58 and submitting a weekly low of -1.34, 65 cents off of its last drop to -1.99. We suspect some of the strength in Z16/Z17 has come from producer hedging, which leads to a flatter curve. In swap markets the 4Q16 WTI swap traded over $53 this week while the Cal ’17 swap briefly reached $54, giving producers new opportunities to strengthen their balance sheets. 

Overseas, China’s crude import data for May was a mixed bag. Overall imports have grown by 15 percent YTD, but May’s drop to 32.24 mt was its second straight m/m decline and raised fears for bullish traders that China’s reserve building may plateau as prices rise. Bloomberg estimates released Thursday showed total OPEC supply down 120k bpd m/m to 32.71 million bpd in May due to a 160k bpd drop in Nigeria to 1.45 million bpd, a 50k bpd drop in Iraq to 4.37 million bpd and a 60k bpd drop in Libya to 250k bpd.

Saudi Arabia, the UAE, Iran and Kuwait expanded production by a combined 270k bpd. Going forward, it seems highly unlikely that Libya and Nigeria’s production will normalize in the near-term and Nigeria’s production has dropped an additional 300k bpd m/m according to some sources to just above 1 million bpd. Markets did take it as a positive sign, however, when Nigerian government officials planned discussions with Niger Delta Avengers in an effort to quell the attacks mid-week, and on Thursday afternoon Shell reported that one if its Bonny Light pipelines was reopened. Back in the Middle East, Clipper Data and Bloomberg both estimated Iran’s May exports at 2.5 million bpd, up more than 1 million bpd since March and a 200k improvement m/m.  Related: Is Colorado Ground Zero For The Next Shale Gas Boom?

Prompt Brent spreads were clearly unbothered by the issues in Libya and Nigeria as Q16/U16 fell to -0.46 for a 30-cent drop since mid-April. On a more bullish note the spread hit a low of -0.48, which was 4-cents better than its May 10th low. In the back of the curve Brent Z16/Z17 made new 2016-highs at -1.47 on Wednesday. In swap markets Cal 17 brent priced above $55 on Wednesday for the first time this year.

Central banks add support across assets

Oil markets received support this week from an investor base which became 98 percent confident (implied by Fed fund futures) that the Fed will not raise rates in June. Most helpfully, the USD reclaimed its downward trend and the EUR/USD rallied back above 1.14. The two key items which drove USD losses this week were Janet Yellen’s dovish speech on Monday and last Friday’s abysmal U.S. jobs data.

The ECB also helped boost equities and fixed income by adding corporate bonds to its asset purchase program this week and China’s trade data for May revealed a 0.4 percent y/y decline in imports which was significantly smaller than expected. The macro outlook wasn’t exactly rosy this week, however, and the World Bank revised their 2016 global GDP growth forecast down from 2.9 percent to 2.4 percent noting that “projections are subject to substantial downside risks, including additional growth disappointments in advanced economies or key emerging markets and rising policy and geopolitical uncertainties.” Nevertheless, S&Ps came within 24 points of their all-time high, reaching 2,119.75 on Wednesday. The U.S. 10 year yield dropped to its lowest mark since February at 1.66 percent.

COT data shows more ‘wait and see’ from funds

Last week’s Commitment of Traders report showed a managed money community which seems content to sit on their collective hands. On the long side, WTI NYMEX gross length for MM was cut for a second straight week to 294k and is lower by 6.4 percent from its 2016 high. ICE Brent length was flat at 384k and is lower by 8 percent from its YTD high. Short positions in both contracts were reduced slightly with the net result being an essentially unchanged position- considerable length in Brent and modest length in WTI over the last three weeks. The producer/merchant category was also essentially flat with NYMEX WTI net short 277k and ICE Brent net short 757k. Investors also pulled money out of the USO for the 17th time in the last 20 weeks.

Slow grind higher sends realized volatility to 2-year low

Owning crude oil options has been a painful experience over the last few weeks. In the ten trading days ended Monday June 6th WTI achieved just a $2.81 range, its most narrow 10-day range since June of 2014 (average 10-day range since Jan ’14 is $6.24), which has sent realized volatility crashing below 20 percent for the first time since October 2014. As a result, implied volatility for WIT N16 options made new 2016 lows with at-the-money options pricing at 30 percent (as of Wednesday afternoon) while 25 delta puts priced at 33 percent and 25 delta calls traded at 32 percent. Over the last three weeks ATM volume for N16 WTI has dropped by about 8 percent. Directional long-options flows have dried up considerably over the last few weeks as a result of the strategy’s hiccups. At the moment, we are having a hard time making an argument to own options for directional bets but expect to see good opportunities to own volatility once realized volume begins to thaw.

DOEs fail to boost market despite large Cushing, overall draws

• Overall stocks have dropped by 11 million bbls over the last five weeks, which is good but not great on a seasonal basis. After two straight draws, Cushing stocks are 2.7 million bbls below their May peak of 68.3 million bbls
• Refiner inputs are flat y/y over the last month but higher by 250k bpd YTD
• U.S. production increased by 10k bpd w/w, the largest weekly jump since January
• Refined product stocks also increased unexpectedly as the east coast continues to get flooded with gasoline imports. On a more positive note U.S. motor gasoline demand is higher by 2.3 percent YTD v. 2015.

Related: Only Five Oil Majors Make The Fortune 500 List

EIA stats revealed crude oil draws that were in line with expectations this week with overall inventories falling by 3.2 million bbls (+13 percent y/y.) Cushing stocks also fell by 1.4 million bbls and PADD II stocks unsurprisingly fell by 1.7 million bbls due to production issues in Canada. PADDs III and V drove a 134k bbl w/w drop in imports to 7.7m bpd (+9.5 percent y/y) and crude production jumped 10k bpd to 8.745m bpd for its largest w/w increase since January.

Refiner demand improved by 210k bpd w/w to 16.4m bpd and is flat y/y over the last month. YTD, however, U.S. inputs have averaged 16.05 million bpd for a 250k bpd improvement against 2015. The WTI 321 crack averaged $16.10/bbl this week which is $8/bbl lower than its 2011-2015 seasonal average. Gasoil/Brent traded near $10.50/bbl ($2.50 below its seasonal avg.) while LLS 321 crack at $9.70 was in line with seasonal norms.


Gasoline data showed a disappointing 1 million bbl build this week against expectations of a 1.3 million bbl draw. Overall gasoline stocks at 240 million bbls are higher y/y by 10 percent and PADD IB stocks are higher y/y by 25 percent. PADD I imports are higher by 42 percent y/y over the last month. Domestic gasoline demand fell 150k bpd to 9.6 million bpd (+2.6 percent y/y over the last month) while exports at 374k bpd are lower y/y by 14 percent. The RBOB/WTI crack rallied to $17 this week and is lower by $2.20 over the last two weeks.

(Click to enlarge)

RBOB futures were generally flat this week in the low $1.60s and it is worth noting that the prompt contract has been making lower daily lows on recent selloffs since May 24th. RBOB N16/Q16’s weakness was somewhat alarming given the number of market participants looking for runaway gasoline demand this summer. The prompt spread flipped from 1 cpg backwardation two weeks ago to 1 cpg contango this week before moderating near -0.80. Traders have pointed to mass quantities of imported gasoline into the east coast as the culprit for spread weakness. 

U.S. distillate inventories suffered a surprise 1.75m bbl build (-500k exp.) following a sharp drop in demand and an increase in imports into PADD I. Overall stocks are higher by 13 percent y/y and PADD IB distillate inventories are higher y/y by 39 percent. Distillate exports at 1.2m bpd are higher y/y by 5 percent while domestic demand is flat y/y over the last month after decreasing to 3.6m bpd this week for a 250k bpd drop. The N16 heating oil / WTI crack rallied to $15/bbl this week to cap a $5 rally since early May.

(Click to enlarge)

Heating oil futures, like the rest of the complex, railed to new YTD highs this week peaking at $1.5848/gl on Thursday for a roughly 50-cent rally since early April. In spread markets N16/Q16 found support twice on the -0.93 line before rallying back towards -0.50. Heating Oil N16/Z16 remains 5 cents in contango after peaking two weeks ago at -4.12.

By Clay Rodgers via SCS Commodities Corp

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