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- WTI rallied back into $50 territory this week with help from positive OPEC speak regarding an output cut renewal, production outages in Libya, Iraq and Canada and compliance levels on output cuts near 95% (via Reuters) for March. We continue to be believers in flat price strength thinking that high levels of OPEC compliance and strong odds of a supply cut extension will make spec-short positions hard to hold once sharp draws to U.S. crude inventories begin in the coming weeks. While bearish inputs such as strong U.S. output and bloated U.S. inventories persist, this week was a good example of OPEC’s influence in talking the market higher and creating headline risk for short positions in similar fashion to what bond traders experienced when the U.S. Fed expanded its balance sheet via QE.

- We still expect lagging U.S. crude demand (both for refiners and refined product consumers) to converge with broadly strong U.S. economic data. This week’s U.S. economic news included an upward revision to 4q16 GDP growth to 2.1% on the back of a steep upward revision in personal consumption to +3.5%. Core PCE for February was also +1.8% y/y. Wednesday’s EIA data returned the favor with strong growth in U.S. refiner inputs and gasoline demand and we expect to see both trends carry on through the summer.

- Option markets are taking this week’s rebound seriously by revealing a diminished put-skew, cheaper volatility across the curve and decreased demand for pricey downside risk. As of Friday morning WTI M17 50 delta options implied 26.5% volatility (down 4 vols since March 10th) while 25 delta puts fell to 28% from 33%. The 25-delta put skew was just above 2-vols (28.2% vs. 26.0%) which was its cheapest relative value in more than five weeks. To be fair to our more bearish friends, demand for upside risk is still muted with wingy 10-delta calls still trading at a discount to ATM volatility.

- It’s also noteworthy that crude oil’s strength came against the headwind of a weak EUR/USD. On the U.S. side hawkish comments from regional Fed Presidents regarding expected rate hikes in 2017 contributed to USD strength while soft inflation data in the Eurozone was seen as decreasing the odds of an ECB rate hike. We’re noticing that more banks are cutting forecasts for USD strength in 1H’17 which also looks favorable for oil prices.

Crude spreads recover on production outages

Brent spreads moved higher this week with help from a 250k bpd pipeline disruption in Libya (still unresolved) and a 2-day outage of a Kirkuk pipeline outage. OPEC also continued to make progress with Reuters reporting March output for the cartel -230k bpd m/m due to 95% supply cut compliance. Russian production was also seen -200k bpd in March and Energy Minister Alex Novak they will cut an additional 100k bpd in April. On Friday Brent M17/Z17 traded -70 for a 30-cent jump on the week while DFL Brent traded -86.

In diff markets light oil continued to rally against WTI on Dakota Access Pipeline demand and news that Syncrude’s 350k bpd Mildred Lake facility shut due to pipe damage for the next 4+ weeks. Syncrude-WTI traded +5.25 on Thursday and Friday notching a 13-month high while Bakken crude traded to +0.75 for the first time since June 2016. WTI outperformed Brent, however, and the M17 arb rallied to -2.26 on Friday with help from improving EIA data that revealed a spike in exports, a surprise draw in Cushing and rapidly falling gasoline and distillate inventories in the US.

(Click to enlarge)

Back in the US, WTI spreads in Cal’17 also strengthened with help from better than expected EIA data and the aforementioned supply disruption in Canada. One of the bullish aspects of the DOE stat report was exports at +1m bpd opposite a draining out of USGC floating storage which has dropped from 14m bbls in mid March to 6m bbls over the last two weeks. As of Friday afternoon WTI M17/Z17 had rallied from -1.40 to -1.00 on the week and continues to forecast extremely sharp stock draws in the second half of the year yielding less than 17-cents / mo in contango. Related: Huge 300,000 Bpd Fracklog Could Derail Oil Price Recovery

US crude production continued to move higher this week printing 9.147m bpd in Wednesday’s EIA report. US output has increased for eight straight weeks and is higher by 697k bpd in just the last six months. The relentless increase in US output has come on the back of rig count increases in 40 of the last 44 weeks. US rigs have reached 662 and have more than doubled since June of last year. As for hedging, COT data in NYMEX WTI for last week showed producer + merchant shorts at 728k contracts following a small w/w decline.

Put skew cheapens on flat price recovery

Option values moved sharply lower across the skew this week but downside risk took a particularly hard hit. As of Friday WTI M17 50 delta options priced at 26.5% losing roughly 3.5 vols w/w while 25 delta puts traded 28% and 25 delta calls implied 26%. The 2-vol premium for 25-delta puts yielded the cheapest downside risk seen in several weeks as traders grew increasingly confident in the flat price recovery. Realized volatility (20-day) was flat this week near 29%. Looking ahead, we continue to have a generally positive view of flat price and would use rallies in downside risk to sell near dated puts when volatility finds a bid.

Fund liquidation came opposite USO dip buying

WTI’s drop from $54 to $47 obviously forced (and self-reinforced) large sums of length-liquidation from funds and generated new short positions in the market. Over the last five weeks WTI NYMEX + ICE Brent net length combined to fall by 259k contracts (-28%) and on the short side the selloff also drew new bearish positions into the market with NYMEX WTI + ICE Brent gross shorts jumping nearly 150% from 84k contracts to 210k contracts.

Refined product markets saw similar trends with RBOB net length and Heating Oil net length falling roughly 45% and 35%, respectively. The preceeding COT data obviously received a large amount of attention in oil market news and was cited as evidence that the managed money community was souring on the prospects for oil market strength. ETF markets, however, told a much different story. Over the last four weeks ended March 24th the USO saw four straight weeks of inflows totaling $408 million. We have frequently cited the curiously strong track record of USO flows in forecasting price trends and would point to aggressive buying of November’s oil dip and subsequent selling of the rally near the top of the market in December as reason to remember that not every money manager speculating in oil is bearish.

Demand increases and product draws lead EIA report

- US crude stocks added 867k bbls w/w which was smaller than expected with help from a 425k bpd pickup in refiner runs and a spike in GoM exports

- Gasoline and distillate fuels both moved deeper into y/y deficit with draws of 3.7m bbls and 2.5m bbls, respectively

- US production remains on a hot streak with eight straight w/w production gains

(Click to enlarge)

U.S. crude stocks increased by less than forecast this week with a modest seasonal increase of 867k bbls. Bullish points for this week’s crude oil data included a sharp jump in refiner inputs of 425k bpd, an increase in exports of 460k bpd to 1.01m bpd and modest crude imports of 8.2m bpd. Cushing stocks also fell by 220k bbls to 67.7m bbls. Regionally, PADD I stocks fell 1.9m bbls and are flat y/y, PADD II stocks fell by 828k bbls and are +3% y/y while PADD III stocks added 2m bbls and are +7% y/y.

On the demand side US refiner inputs jumped from 15.8m bpd to 16.23m bpd which is in line with 2016’s data. Over the last month inputs have lagged last year’s numbers by 1.5% and utilization at 89.3% is lower y/y by 2.3%. Prompt crack margins were generally free of exciting news with RBOB/Brent trading $18/bbl, WTI 321 trading $18.70/bbl, Gasoil/brent near $10.30 and LLS 321 near $13.30. Related: The 5 Biggest Strategic Petroleum Reserves In The World

US gasoline data was also better than expected beginning with a 3.7m bbl overall stock draw. PADD I lead the way with a 2.5m bbl w/w decline with help from decreased imports and stocks in PADD IB are now lower y/y by about 1m bbls. PADD II stocks fell 340k bbls and are +2% y/y while PADD III stocks dropped by 1.5m bbls and are lower y/y by 4%. On the demand side stats also revealed a 324k bpd jump in domestic consumption (+3% y/y) while exports at 608k bpd are +53% y/y.

US distillate inventories also fell by more than expected with a w/w decline of 2.5m bbls. Overall stocks are now lower y/y by 5% with PADD IB stocks lower y/y by 1.4%. PADD II stocks fell by 400k bbls w/w and are lower y/y by 5% while PADD III inventories fell 738k bbls and are lower y/y by 10%. Domestic distillate demand continues to show strong y/y growth and its print of 4.2m bpd this week gets US demand to +10% y/y. Distillate exports at 1.1m bpd are -16% y/y.

US distillate inventories also fell by more than expected with a w/w decline of 2.5m bbls. Overall stocks are now lower y/y by 5% with PADD IB stocks lower y/y by 1.4%. PADD II stocks fell by 400k bbls w/w and are lower y/y by 5% while PADD III inventories fell 738k bbls and are lower y/y by 10%. Domestic distillate demand continues to show strong y/y growth and its print of 4.2m bpd this week gets US demand to +10% y/y. Distillate exports at 1.1m bpd are -16% y/y.

By SCS Commodities Corp.

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