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OPEC Deal At Breaking Point As Compliance Falls

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WTI has traded in a $3.90 range so far in July ($43.65 / $47.55) and the sideways price action has lead to waning market enthusiasm for bulls, bears and option traders who are betting aggressively on a quiet market. Over the last two weeks fund gross long positions in NYMEX WTI haven’t budged while gross short positions have been cut by 28%. In ICE BRENT speculators have also been inactive on the long side while cutting gross shorts by 13%. In options markets WTI U17 at the money implied volatility has dropped to a multi-week low at 28% on a lack of large directional bets which have been justified by a 2-month low in realized volatility (20-day) to 26%. Lastly, even retail is getting less excited about crude having withdrawn $450m from the USO in the last two weeks.

- So where will we find excitement? Next week’s calendar includes an OPEC + Russia strategy meeting on Monday which is unlikely to yield a policy shift, a Fed rate decision with 97% odds (via Fed funds futs) of unch, possible public hearings with Don Jr, Paul Manafort and Jared Kushner and a DOE report which we think will prolong the two week stretch of strong data. We think that, if anything, this news cycle skews risk to the upside and it could be worth using newly cheap options to play for another leg higher. On the OPEC side, Petroleum Policy Intelligence commented this week that Saudi leadership is considering taking another 1m bpd off the market and Senate Intel hearings will- if anything- prolong the slide in the DXY. Both events could briefly shift prices higher with help from a DOE report which we think will show decreased Saudi imports, a strong headline crude oil draw and elevated demand driven by the recent spike in global refining margins.

- OPEC data was mixed this week reminding us of two important themes - 1, OPEC members are pushing the limits of the current output agreement and 2- recent gains in Libya and Nigeria could be hard to maintain. On the first item, preliminary estimates see July OPEC production +145k bpd m/m which would represent a new YTD high in the cartel’s output and sow additional doubts about their ability to coordinate supply cuts. Meanwhile Iraq is publicly promoting its plan to ramp production up to 5m bpd by year-end (from 4.4m bpd in June) and Ecuador stated that they will no longer participate in cuts in an effort to strengthen their finances. As for the second item, Nigeria’s production and export woes were headline news this week due to pipeline vandalism. All-knowing prompt brent spreads digested the week’s news flow and moved slightly higher. Brent V17/Z17 rallied to -55 cents on Friday forecasting a reasonably strong supply/demand balance in coming month.

(Click to enlarge)

For spreads- inventory draws vs. future output

WTI spreads continued to moderate this week with help from drawing overall stocks and sub 58m bbls in Cushing. On the demand side refiner inputs continue to impress and could be aided in the near term by a rally in US margins to new YTD highs. In front spreads WTI U17/Z17 yielded just 22 cents / mo contango suggesting large inventory draws should persist in the US through the balance of the year. On the downside, however, we saw limitations to potential rallies in the swap market where producers were busy selling WTI Cal ’18 near $49/bbl. CSO markets also saw bearish flows with trade groups building short positions in flat calls in 4q17 and 1h18.

US producer data showed a slight uptick in hedging w/w while the rig count flattened and output continued to increase. Overall production came in at 9.43m bpd last week for a 32k bpd w/w improvement. Output in the US has recovered by more than 1m bpd from its Summer ’16 low and is within 180k bpd of its 2015 high. The US rig count actually fell by 1 w/w to 764 and is higher by 44 rigs over the last ten weeks in a clear slowdown relative to the previous ten week period where they increased by 95 rigs. The producer + merchant short between NYMEX WTI and ICE BRENT stands at 1,872k contracts- 13% below its March high.

Funds cut bait and run in both directions

Speculators were net buyers of NYMEX WTI and ICE Brent contracts last week due to short covering rather than any new bullish excitement in the market. Combined net length between the two main contracts jumped 8% w/w (30k contracts) as gross shorts were cut by 45k contracts. The total gross short in the market is still 40% above its 2yr average and looks capable fueling more short cover rallies. Related: New Solar Tech Produces 50% More Energy Than Silicon Cells

Funds were also net buyers of refined products last week on short covering. The net position in RBOB futures and options flipped to a long of 7k contracts while the net short in heating oil was cut from 21k to 11k. As for ETFs, the USO experienced a net sell of $93m last week bringing the two week total to $450m as retail money throws in the towel on long-oil ideas.

Sideways market sends options lower

Option values in the front of the curve were cheaper this week for at-the-money strikes and downside risk while call options strengthened. As of Friday WTI U17 atm vol priced near 28% which was 2 vols lower w/w and wingy call options traded to a premium on 50d vol for the first time in recent memory. In the back of the curve WTI M18 50d vol was basically unchanged w/w near 30% and 25d puts traded at a 7-vol premium to 25d calls. 20-day realized volatility sank to 26% this month for a 2-month low suggesting prompt option premiums could fall further in the near term.

(Click to enlarge)

DOE stats continue to strengthen

- Wednesday’s data showed better than expected draws across products including a 4.7m bbl crude draw despite heavy PADD III imports

- US refiner inputs continue to look strong and should be able to keep a bullish pace due to recent margin improvements

- US producers continue to pump at warp speed and dampen the potential for a bull run in flat price. Our view is that strength across the $50 mark in WTI swaps would generate a mountain of hedging.

US crude inventories fell 4.7m bbls w/w and are now flat y/y at 491m bbls. Regionally, PADD I stocks fell 1.3m bbls (-10% y/y,) PADD II stocks fell 2.6m bbls (+1.5% y/y) and PADD III inventories fell 721k bbls (+1% y/y.) Cushing inventories fell 23k bbls w/w and stand at 57.5m bbls. Imports saw a significant w/w jump to 8m bpd (+386k bpd w/w) and are lower y/y by 1.7% over the last month. Exports declined by 190k bpd w/w to 728k bpd.

US refiner demand continued its bullish trend last week printing 17.1m bpd. Overall inputs are higher y/y by 2.4% with PADD I runs flat y/y, PADD II runs +4% y/y and PADD III inputs +4.5% y/y. Refinery utilization is currently running 94% which is higher y/y by 1% and seems poised to maintain its recent trend after margins have improved across the US and overseas. The WTI 321 crack traded over $20/bbl this week representing at $5 rally over the last month. For east coast refiners RBOB/Brent rallied to nearly $17/bbl and overseas gasoil/brent traded up to $12/bbl for a 2017-high. Related: The Abrupt Demise Of Dutch Gas

US gasoline inventories also had a stronger than expected headline number with an overall w/w decline of 4.4m bbls. Overall inventories are now lower y/y by 4.1%. By region, PADD I inventories are -10% y/y, PADD II stocks are +1% y/y and PADD III stocks are flat y/y. On the demand side domestic consumption remains unimpressive printing 9.6m bpd which is lower y/y by 2%. Exports last week were 573k bpd and higher y/y by 45% due largely to LatAm demand increases. YTD domestic demand + exports are higher y/y by less than 1%.

US distillate inventories fell 2.1m bbls w/w which was a much stronger number than expected. Overall inventories are now -1% y/y. Regionally, PADD IB inventories fell 1.3m bbls and are -6% y/y, PADD II stocks fell 1.2m bbls and are +7% y/y and PADD III stocks added 990k bbls and are +8% y/y. Distillate exports printed 1m bpd last week and are -20% y/y over the last month. Domestic demand printed 4.3m bpd and is higher by 11% y/y.

By SCS Commodities Corp.

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