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What Do Brent Spreads Know That We Don’t

What Do Brent Spreads Know That We Don’t

• The most important fundamental development of the week, in our minds, is the evolving market share battle among OPEC + Russia. Saudi Arabia sold a spot-market cargo to China early this week for the first time in recent memory, Iraq's southern exports have reached a record high, forecasts for 2Q16 OPEC output are rising and rhetoric regarding coordinated output cuts was bearish. The cultural and strategic differences between major exporters are clearly not being mended by +15 months of sinking FX reserves and revenues; the battle for market share is alive and well.

• In the U.S., weak DOE stats halted recently bullish trends of tightening Cushing stocks and steady growth in refinery inputs and mogas demand. Cushing also registered its largest w/w build since December of 1.75m bbls. Refining margins have improved but remain at their weakest seasonal levels in years. Production, however, dropped yet again and is down 297,000 bpd YTD.

• USD weakness served as a key support for oil this week. The FOMC left overnight rates unchanged and modified their outlook giving a more positive view of global markets while seeing new domestic soft spots. The BOJ added to the weak USD by unexpectedly sitting on their hands following a multi-year low print in CPI. Fed fund futures imply a 15 percent chance of a June rate hike, down from 23 percent to begin the week.

• For the last two weeks we’ve forecast a $38/$48 range for WTI and the current threat for that prediction is now obviously towards the upside with WTI seemingly on a mission to crack $50. While we see +50/50 odds of WTI M16 breaking $50, we feel that level would be difficult to sustain with OPEC members more aggressively fighting for market share and U.S. producers likely to sell large quantities of oil forward should calendar swaps continue to rally. Psychologically, we also believe that it could be difficult for bullish speculators to hold onto their current record- high long position over $50 after enjoying what would be a nearly 100 percent rally since mid-February.

What do Brent spreads know that we don’t?

If our view of $38-$48 oil turns out to be too bearish, it will probably be because there is something that Brent spreads are trying to tell us that just isn’t computing. Brent’s front 1-month spread traded to +0.38 this week while M16/Z16 (Nymex crude Jun ‘16 respectively December ’16) rallied from a low of -1.90 on Monday to -1.15 by Thursday afternoon.

The strength came despite Reuters reporting that Iraq’s southern (i.e. non-Turkey bound) exports reached a record of 3.43m bpd in April through the 25th while Saudi Arabia sold a spot-market tanker with capacity of 730,000 bbls to an independent Chinese refinery marking an aggressive shift in marketing policy. BMI Research expects Saudi output to increase by 200,000 – 300,000 bpd this summer in response to higher Iranian output, while Citi analysts suggested that the Kingdom could increase supplies by 500,000 bpd (increasing production to 11m bpd) in the coming months. Related: Venezuela’s Electricity Blackout Could Cut Off Oil Production

Morgan Stanley analysts see total OPEC output rising by 1m bpd between March and June to 33.5m bpd. Additionally, Russian leadership noted there were no plans to discuss supply cuts prior to OPEC’s June meeting and Saudi leadership repeated their stance that they will only consider output cuts if all OPEC members and certain non-OPEC exporters are involved.

We acknowledge that reduced output from Latin America, a surge in buying from China and unexpected OPEC outages should have made Brent structure tighter in recent months, but at the moment we are scratching our heads at the strength of Cal ’16 Brent spreads while OPEC + Russia signs point to a more competitive fight for market share.

WTI spreads were also strong this week despite a significantly larger than expected U.S. inventory build, a 1.75m bbl build in Cushing and a w/w decline in refiner demand which is unusual for late April. WTI M16/N16 rallied from -0.95 to -0.81 while M16/Z16 ran from -3.00 to -2.40. The 4Q16 WTI swap made new 2016 highs near $47 and our suspicion is that the $50 level would be met with selling pressure from producers.

Going forward, if WTI spreads continue to levitate against weak refining demand and seasonally poor margins, we may want to sell WTI CSO 4Q16 flat calls looking to collect 20-cents (currently worth 0.16) believing that WTI spreads are unlikely to flip into backwardation without significant acceleration in gasoline and distillates demand and refiner inputs.

Central Bank-rich week sends USD reeling

Oil markets were treated to a variety of macro inputs this week and none of them helped slow the recent plunge in the DXY which has helped lift crude. On Wednesday, The U.S. Fed left its overnight benchmark rate unchanged at 0.25 percent - 0.50 percent and gave a more positive view of global financial markets but noted that domestic inflation had softened.

While commentary also included a positive view of U.S. labor trends, markets clearly interpreted the statement as accommodative and the USD selloff was accompanied by a drop in the U.S. 10-year yield from 1.94 percent to 1.82 percent. The Bank of Japan exacerbated the USD weakness on Thursday by responding to an extremely weak -0.4 percent y/y CPI reading for March without any further stimulus. U.S. Fed fund futures implied a 23 percent of a rate hike at the Fed’s June meeting early in the week but saw only 15 percent odds after a preliminary reading of 1Q16 US GDP printed just 0.5 percent on Thursday- its worst reading in two years.

The USD Index dropped as low as 93.7 on Thursday to match its April 12th low print for a 1.5 drop on the week and is lower by nearly 6 pts since January’s high. As we attempt to illustrate below, oil remained highly correlated with EUR/USD and S&Ps this week persisting as a thorn in the side of bearish traders who believe that $46 WTI is fundamentally unjustified.


Fast money still loves crude oil, real money keeps selling

USO flows have remained strongly negative in April and the fund has seen outflows in seven of the last eight weeks. Through April 25th the fund has seen net outflows of about $365m after suffering outflows of $599m in March. Speculators in NYMEX WTI and ICE Brent, however, cut gross short positions in both contracts for a second straight week, added gross longs in WTI for a second straight week and added gross longs in Brent for a sixth consecutive week.

The record-high net long position in brent is higher by 36 percent YTD while the speculative net long in NYMEX WTI is higher YTD by 220 percent. Net length in NYMEX RBOB for speculators is in-line with its 1-year average at 23,000 while the net short in heating oil has been cut to 8,000 from as high as 45,000 in November. Producer/merchants reduced their gross shorts to 503,000 which is 9,000 below its 4-year high reached in February.

Option premiums deteriorate on move over $45

Oil’s continued strength pushed the NYMEX/CBOE OIV index below 43.0 for the first time this year while WTI N16 implied volumes continued to shrink across the skew. As of Tuesday, WTI N16 (Crude July ’16) 50 delta options dipped slightly below 40 percent implied volume, 25 delta puts priced at 43 percent and 25 delta calls cost 38 percent. Away from oil markets EUR/USD implied volume also made a new 2016-low this week at 7.7 percent while the VIX was subdued near 13.7.

Related: How The Debacle At Doha Marked The End Of An Era

DOE report hits the pause button on recent hot streak

• Cushing reports largest w/w build since December of 1.75m bbls

• Large builds in PADDs II and III bring overall stocks to new record high at 541m bbls- +10 percent y/y

• Refiner inputs record a seasonally unusual drop of 257,000 bbls w/w

• 1.6m bbl gasoline inventory build comes alongside 129,000 bpd drop in demand

This week’s DOE report showed a 2m bbl w/w build which brought overall U.S. crude stocks to a 10 percent y/y surplus. The addition included a 1.6m bbl increase in PADD II (+6 percent Y/Y) and a 1.1m bbl build in PADD III (+17 percent y/y.) Cushing stocks broke their recent string of draws with a 1.75m bbl build to bring inventories in the hub back to 66m bbls. Imports fell sharply – by 320,000 bpd in PADD I and 440,000 bpd in PADD III – to 7.55m bpd and are roughly flat y/y over the last four weeks. U.S. crude oil production fell for a seventh straight week to 8.94m bpd and is lower by 297k bpd since January.

In product markets RBOB futures continued to look technically strong this week touching $1.5920 on Wednesday for a nearly 20-cent rally since April 18th. RBOB spreads were roughly flat on the week with M16/Z16 hitting resistance at 25.00 before weakening to 23.7.

US refiner inputs were a disappointing 16.1m bpd last week which is the metric’s second y/y deficit print in the last three weeks. Overall refiner inputs are higher by 2 percent YTD. Looking forward, we continue to view refining margins as a source of concern for oil markets with the WTI 321 crack ($19/bbl), gasoil/brent crack ($8/bbl) and LLS 321 crack ($11/bbl) trading at multi-year seasonal lows despite recent gains.  

US gasoline inventories made a seasonally abnormal jump of 1.6m bbls due to increases in PADDs I and III of 1.3m bbls and 580,000 bbls, respectively. Overall mogas stocks remain higher by 6 percent y/y and PADD IB stocks are higher by about 100k bbls y/y. Domestic mogas demand fell by more than 125k bpd w/w but remains higher by 2 percent YTD. Mogas exports at 413,000 bpd are lower y/y by 28 percent.



Distillate inventories were one of the few bright spots of this week’s report drawing 1.7m bbls w/w. Unfortunately, overall distillate stocks remain higher y/y by 22 percent and PADD IB stocks are higher y/y by 90 percent. PADD II distillate inventories are flat y/y following this week’s 1.6m bbl draw and PADD III’s distillates are higher y/y by 17 percent following a 170k bbl draw. Domestic distillate demand fell by 154,000 bpd w/w to 4.1m bpd and is flat y/y over the last month. Distillate exports at 949,000 bpd are lower y/y by 7 percent. Related: Massive Oil Theft By Pirates Costs Nigeria $1.5 Billion Every Month

Heating oil futures made higher daily highs each day this week and eventually traded up to $1.3925/g on Thursday for a 33-cent rally off of their April 5th lows. Heating oil spreads in Cal ’16 continued their bullish move with M16/Z16 trading up to -8.75.


[1] Cho, Sharon. Oil Buyer’s Guide. Bloomberg. April 26 2016.

[2] Cho, Sharon. Oil Sales to China Teapot ‘Dramatic’ New Cahpter for Saudis: Citi. Bloomberg. April 25 2016.

[3] http://www.zerohedge.com/news/2016-04-26/will-algos-push-oil-back-60-morgan-stanley-begs-you-forgive-macros-they-know-not-wha

By Clay Rogers via SCS Commodities Report

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