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Something Has Got To Give In Oil Markets

Escravos Oil Storage

- Oil wrestled with positive fundamental expectations and bearish present circumstances this week to remain glued to the $53 mark. In the present, stress of record high crude oil and gasoline inventories in the US resulted in a 2 cpg drop in the prompt 1-month gasoline spread. Meanwhile positive fundamental expectations were revealed in the steady climb of the Brent June/July spread which yielded just 14 cents contango suggesting that physical traders see massive inventory draws in the middle of 2017. In flat price the result of the tug of war between present bearish circumstances and positive expectations has been an extraordinarily sideways market near the $53 mark. Year to date WTI has managed a range of just $4.53. Over the last twenty trading days WTI has managed a range of just $3.12- the last time WTI had a 20-day range of $3.12 or less was in July of 2003 when it posted a 20-day range of $2.93. Option values have melted as a result of the sideways trading with implied volatility sinking to a 1-month low at 24% while realized volatility (20 day) fell to a 2.5yr low at 19%.

- Looking forward, it’s starting to feel like falling implied vols and rotting breakevens will make owning volatility worthwhile in the coming weeks. While the historical record of buying 24% implied vol opposite 19% realized vol is mixed, it does seem to us like the extraordinarily bearish present circumstances in the market and extremely bullish expectations for the coming months will make sideways $53 oil unsustainable. This week’s striking divergence in RBOB spreads versus prompt WTI and Brent spreads reveal that there is significant stress in the market that could easily transmit volatility into flat price in the near future.

- Away from the oil market Janet Yellen gave a mostly positive assessment of the US economy this week citing improving inflation and labor market conditions. In our view the normally accommodative Yellen seemed unusually concerned with the risks associated with rates being too low for too long. The reliably dovish Boston Fed President Eric Rosengren also made waves this week commenting that the current Fed forecast of three rate hikes in 2017 may be too low to counteract the forces of increased inflation, employment and asset prices. Fed fund futures currently see only 18% odds of a rate hike in March and 44 percent odds of a rate hike in May which could introduce bearish risk into the oil market if FX traders are caught off sides in the spring by an unexpected rate hike.

Brent spreads still bullish despite Nigeria, Libya gains

Brent spreads were strong in the front of the curve and flat in Cal ’18 this week as the market continued to digest better than expected compliance with OPEC production cut agreements. By Friday afternoon Brent DFL had strengthened to -77 cents and J7/M7 jumped to -50 cents for an eight month high. Further back, Brent Z17/Z18 was flat near -100 as producer hedging kept Cal 18 steady. Bearish news continued to come from Africa where Libya reported output of +700k bpd (from 690k bpd in Jan) and Nigeria reported current output of 2m bpd (up from 1.64m bpd in Jan.)

Related: Trump Burning Bridges In Iraq Over “Take The Oil” Comments

WTI spreads behaved in a similarly bullish fashion this week looking ahead to large draws in the spring despite another poor round of EIAs which brought US and gasoline inventories to record high levels. The WTI m2-m4 spread traded to a 2-month settled over -60 cents on Friday for the first time in four months and is higher by about 60 cents since mid January. In the back of the curve the WTI Z17/Z18 spread flipped into backwardation yet again this week moving to +40 cents for a 79 cent rally over the last eight trading sessions.

Funds hit the pause button on buying spree

COT data for the week ended February 7th showed fund managers as net sellers of both NYMEX WTI and ICE Brent contracts for the first time since mid November. Net length in NYMEX WTI at 359k is higher by 33% since early December while net length in ICE Brent is flat over the same period. On the short side we saw additions to gross short positions in both contracts increase (although by modest amounts) in both contracts for the for the first time since late December.

 

(Click to enlarge)

Product markets also saw a decrease in bullish enthusiasm as RBOB net length decreased for a fourth consecutive week and is lower by 23% over that period. Heating Oil net length was flat near 35k contracts as it has been for the last six weeks. In ETF land the USO saw its largest weekly net inflow ($87 million) since mid November.

Options still in the gutter, but wingy calls rally

Another week of sideways trading for flat price was obviously not helpful for option premiums. WTI J17 50 delta implied volatility was slightly lower w/w and lower by 3 vols over the last two weeks near 24%25%. Meanwhile 25 delta puts traded near 27% and 25 delta calls implied 25%. On the bullish part of the skew we think it’s important to note that 10 delta calls continue to trade at a premium to 25 delta calls for the second striaght week reflecting heightened interest in upside risk from funds. Making money from the long-vol side in options remains tricky, however, as realized volatility sank to a 2.5 year low this week at 19.07%.

Rebalance Delayed: EIAs wreak bearish havoc yet again

• Larger than expected builds brought gasoline and crude oil inventories to new all-time highs
• Through the first six weeks of 2017 US crude stocks have increased by 35m bbls which is equal to the same period during 2015. Crude stocks increased by 22m bbls through the first six weeks of 2016.
• Demand data continues to look erratic on a number of levels but US refiner inputs and US implied gasoline demand still remain slightly higher y/y through the first six weeks of the year

Crude stocks jumped 9.5m bbls w/w to their highest mark ever at 518m bbls. Overall US inventories are higher y/y by 10% over the last month with help from steady crude production near 9m bpd. Regionally, PADD I inventories are higher y/y by 6%, PADD II inventories are flat y/y, PADD III inventories are higher y/y by 19% and Cushing stocks fell 700k bbls to 64.6m bbls. The majority of this week’s inventory buildup came from PADD III where stocks increased by 6.8m bbls despite a drop in imports into the USGC, a modest decrease in refiner inputs and a sharp increase in exports to over 1m bpd.

US refiner inputs had a sharp w/w drop of 435k bpd to 15.5m bpd. Overall inputs are higher y/y by 1.2% over the last month but regional differences remain strong with PADD I inputs -4.5% y/y, PADD II runs -1% y/y and PADD III runs +3% y/y. Utilization fell 2% w/w to 85.4% and is flat y/y. As for margins, the WTI 321 crack trended slightly lower this week towards $12.25/bbl while RBOB/Brent was steady near $18/bbl.

US gasoline suffered another round of horrendous data beginning with a 2.24m bbl build in PADD IB where inventories are now higher y/y by 15%. Overall gasoline stocks jumped to an all time high of 259m bbls (+2.8m bbls w/w) and are slightly higher y/y. PADD II stocks fell by more than 500k bbls and are -2.6% y/y while PADD III inventories added 188k bbls and are -2.4% y/y. Domestic gasoline demand fell by 510k bpd to 8.4m bpd and is lower y/y by 8% over the last month while exports at 555k bpd are +21% y/y. Related: Solar Installations Surge 95% In 2016

Gasoline futures and spreads moved sharply lower this week under the strain of record high inventories in the mid Atlantic region. In flat price the prompt contract moved to a weekly low of $1.49/gl on Friday nearly matching its low from last week and maintaining its bearish momentum after pearking at $1.70/gl on January 3rd. Spread markets also came under signficant pressure due to the glut of gasoline in NY Harbor with RBOB H17/M17 moving from -21 cpg last week to -25.5 cpg on Friday.

 

(Click to enlarge)

Distillate data was significantly better than either crude oil or gasoline stats leading with a 1.9m bbl draw in PADD IB where inventories are higher y/y by 7%. Overall distillate stocks are +5% y/y. PADD II stocks are +2.5% y/y following a 410k bbl build and PADD III inventories are flat y/y following a 440k bbl build. Distillate demand was flat w/w at 3.85m bpd and +11% y/y while exports at 992k bpd are -18% y/y.

Heating oil futures shifted to a two week low on Friday printing $1.61/gl for a six cent loss w/w. The H17 contract is currently trading towards the low end of its 2017-range of $1.76/gl to $1.60 on the year in a somewhat bearish pattern. In prompt spreads there was short covering in the H17/M17 spread in a move slightly above -3 cpg.

Overseas, gasoil stocks in the Amsterdam-Rotterdam-Antwerp hub fell by 300k mt w/w and are lower y/y by 8.5% over the last month. Fuel oil stocks in the region jumped by about 60k mt but are lower y/y by 38% over the last four weeks. Distillate stocks in Singapore fell by about 2m bbls w/w but are higher y/y by about 2% over the last month.

By SCS Commodities Corp.

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