- In a 1999 episode of the iconic TV series The West Wing (yes, iconic) President Jed Bartlet was dealing with a crisis. The Syrian government had shot down a US military plane and his advisors were busy working to devise a ‘proportional response’ for the President’s consideration. Bartlet listened to the proposals for limited military action and became furious, exclaiming ‘what is the virtue of a proportional response?! He then argues that only disproportional responses are effective in pursuing wholesale change abroad, but ultimately decides to pursue a proportional response plan to avoid sowing chaos in the Middle East.
- Late Thursday night the US military countered Assad’s use of chemical weapons against civilians with what Pentagon spokesman Capt. Jeff Davis and SoS Tillerson described as a ‘proportional’ response. The strikes’ focus on Syrian military assets marked an important shift in US policy following years of ISIS-focused bombing from the Obama administration and was (according to Gen. McMaster) effective in damaging, but not eliminating, Assad’s ability to deploy chemical weapons. Early assessments suggest the air strikes were at least moderately successful in eliminating military targets and clearly were not an effort to drive regime change in Syria.
- Given the proportional nature of the US response we’re viewing the situation in Syria as unlikely to inject substantial geopolitical risk into the oil market in the near term. From the US’s viewpoint the strikes were obviously focused on preventing the use of chemical weapons- not an effort to catalyze a second Arab Spring. On the other side of the table Syria, Russia and Iran are seriously limited in terms of response options and Iran and Russia are strongly incentivized economically to allow the situation to cool.
- The oil market’s reaction to the air strikes also suggested a lack of concern for geopolitical and supply risk. In flat price, Brent M17 gained just 35 cents on the day while the prompt 1-month brent spread traded unchanged at -29 cents. Option markets were also curiously cheap with implied and realized volatility for WIT M17 near 5-week lows of 25% and 21%, respectively. Upside risk insurance in the form of 10 delta calls also continued to trade at a discount to ATM options.
The Tale of Two Cities for North American Crude
Prompt WTI spreads moved sharply higher this week despite a more bearish than expected EIA report that included a +1.4m bbl build in Cushing. Overall inventories in the US are +7.5% y/y and roughly 35% above their 5yr seasonal average but that didn’t stop WTI K17/M17 from rallying to -0.40 on the back of continued strength in light oil on production issues north of the border and DAPL fill. Both trends pushed Syncrude-WTI over +5.00 while Bakken-WTI traded up to 1.35 this week for a +2.90 rally on the month. WTI did enjoy a small relief rally v. Brent, however, with the M17 arb running from -2.80 to -2.55.
Further south, Midland continued to trend into a steep discount to WTI as gains in production overwhelmed takeaway capacity. On Friday morning Midland-WTI traded near -1.15 for a $2.75 loss over the last four months as US production jumped to 9.199m bpd to its highest mark since January 2016. US production has recovered by an incredible 771k bpd over that last eight months and continues to drive bearish sentiment among Houston trade groups and funds who have been aggressive buyers of -25, -50 and -100 puts in 2h’17 WTI CSOs over the last two weeks. As of Thursday’s close open interest in 2H’17 CSO puts between WA and 7A contracts totaled 710k contracts while 2H’17 WTI CSO calls stood at just 272k contracts.
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EIA’s fail to match API draw
• US crude stocks added +1.6m bbls w/w which is a modest inventory addition for late March but failed to match the bullish sentiment created by Tuesday’s API crude draw.
• If you really want to get bearish look no further than the relentless increase in US crude production which of course increased w/w by 52k bpd to 9.199m bpd
• US refiner demand had a strong jump of 200k bpd and his higher by about 600k bpd over the last two weeks. We still need to see growth in US refiner inputs and domestic gasoline demand to create a truly bullish environment for oil
US crude stocks added 1.6m bbls w/w to reach a new record high of 536m bbls. Overall inventories are higher by 7.5% y/y and roughly 35% above their 5yr seasonal average. By region, PADD II inventories added 312k bbls and are +3% y/y, PADD III inventories added 2.7m bbls and are +9% y/y. Cushing stocks also added 1.4m bbls and now stand at 69.1m bbls. As for trade flows, overall imports fell 374k bbls w/w to 7.85m bpd and are +2% y/y over the last month. Exports fell sharply from 1m bpd last week to 575k bpd which helped contribute to the USGC build. Related: Tanker Traffic Points At Much Tighter Oil Markets
US refiner inputs jumped by 200k bpd w/w to a modest y/y gain after increasing by 1.1m bpd over the last six weeks. Overall inputs currently stand at 16.4m bpd and are lead by PADD II runs which are +8% y/y while PADD III runs are -2.6% y/y. Refinery utilization printed 91% and is lower y/y by 1.6% over the last month. Refining margins were mostly flat this week with RBOB/WTI near $21/bbl and HO/WTI near $16/bbl leaving the WTI 321 crack at $19.25/bbl. On the east coast RBOB/Brent traded $17.50 and overseas the gasoil/brent crack traded $10.50/bbl.
US gasoline data showed a w/w draw of 618k bbls bringing overall stocks to a y/y deficit of 2%. PADD II stocks lead the draw with a decline of 1m bbls and are +1.4% y/y while PADD III inventories were flat w/w and are -6% y/y with help from steady export activity over the last month. In the mid-Atlantic PADD IB stocks fell by about 500k bbls and are lower y/y by about 2%. As for demand, gasoline exports fell slightly w/w to 590k bpd and are higher by 50% y/y over the last four weeks. Domestic consumption fell to 9.25m bpd and is flat y/y over the last four weeks.
Distillate data showed a smaller than expected overall draw of 536k bbls bringing overall stocks to a y/y deficit of 6.5% over the last four weeks. PADD I lead the draw efforts with a 3.4m bbl decline and east coast stocks are now lower y/y by 2%. In the mid-Atlantic PADD IB inventories are flat y/y. Domestic distillate demand continues to be one of the more bullish inputs in the US crude market and after a slight w/w decline to 4.1m bpd is +13.5% y/y over the last month. Distillate exports printed 1.1m bpd and are +4% y/y.
COT data shows more selling as crude found support
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Crude oil’s recent bearish move found its bottom on March 27th so it was not surprsing that COT data for the week ended March 28th revealed a fifth straight week of net selling from speculators. For NYMEX WTI speculators were net sellers of about 16k contracts w/w shedding a total of 40% of their net length over the six week period. In ICE Brent funds were net sellers of about 29k contracts and removed about 27% of their long position over the same six week period.
Refined product flows showed a similarly bearish trend as gasoline and heating oil sold off and net length was virtually whiped out in both contracts. As of March 28th managed money net length in RBOB stood at 18k contracts (down from 49k in mid February) while heating oil net length had dropped to 19k from 34k in mid February. USO flows broke a streak of four straight weeks of buying as investors were net sellers of the ETF to the tune of $28 million for the week ended March 31st.
By SCS Commodities Corp.
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