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What Oil Needs To Rally Higher

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- Oil found much needed support from currency markets this week on a strong EUR/USD following comments from ECB chief Mario Draghi that the Eurozone’s central bank could be ready to taper asset purchases earlier than previously expected. As a result, EUR/USD traded to a 13-month high over 1.1400 and helped initiate a short cover rally in WTI and Brent off of 7-month lows.

- Going forward traders looking for a continued run in EUR/USD to lift crude will need to monitor hawkish Fed rhetoric from Yellen + co. who seem hell bent on another rate hike in 2017 against skeptical Fed fund futures which only see 54% odds of another increase by the conclusion of the FOMC’s December 13th meeting. This week we think it was noteworthy that Janet Yellen brought attention to ‘somewhat rich’ asset levels while St. Louis Fed President Bullard lamented falling prompt yields following the most recent rate hike. Meanwhile US 1Q GDP growth was revised higher than expected to 1.4% and 1Q personal consumption was revised higher than expected to +1.1% y/y. We still have a positive view of $45 WTI, but wouldn’t count on a continued meteoric EUR/USD run to underpin the crude oil rally as long as US financial conditions remain buoyant and the rhetoric of Fed officials is more hawkish than Fed fund futures would imply.

- Short covering also playing a key role in the current oil rebound as hedge funds have honored their tradition of getting massively bearish as the market was finding support levels. In this case the current gross short held by funds between NYMEX WTI and ICE Brent stands at 336k representing a 10-month high which is 1.75 standard deviations above its 2yr average of 199k contracts. We’re looking for some additional upside risk in crude oil prices until speculative short positions normalize.

- In terms of gauging sentiment it’s noteworthy that crude oil rallied nearly $3 from Monday morning through the Friday close despite a scarcity of fundamentally bullish news items. DOE data was soft (to put it nicely) on Wednesday with a seasonally abnormal crude oil inventory build and continued weak domestic gasoline demand. Bloomberg’s global floating storage tracker also reached an all-time high of 209m bbls on Wednesday suggesting a significant overhang of oil in less-visible regions and Libya and Nigeria continued to ramp up both production and exports to unexpected levels. Russia’s energy minister also added to the mix by commenting that there currently are no plans among OPEC + Russia to steepen production cuts.

- On a more bullish note brent spreads were notably resilient this week despite the onslaught of bearish news out of Libya and Nigeria. Dated brent vs. the 1-month swap traded to a 5-week high on Tuesday at -62 suggesting heightened Chinese buying and OPEC cuts are maintaining a reasonably high floor in the physical market for the time being. 

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Cushing, how low can you go?

Cushing inventories have dropped in ten of the last eleven weeks falling from 69.4m bbls in early April to 60.8m bbls as of last week. The inventory declines in the hub have been the key component of Cal ’17 WTI spread support while flat price and deferred spreads tanked but we’re starting to wonder how much lower Cushing inventories can fall given that stocks are within 2m bbls of their 2016 seasonal low while PADD II and PADD III stocks are bloated and PADD III floating stocks have surpassed 10m bbls for a 3-month high. US crude exports have also disappointed averaging less than 525k bpd over the last two weeks Related: The World’s Largest LNG Buyer Just Completely Reshaped The Market

Given the bearish set of circumstances geographically surrounding Cushing we think the hub’s aggressive draws are unsustainable beyond the 57m bbl – 58m bbl mark and would look to pursue short Cal ’17 WTI and 1H’18 spread strategies via futures spreads and WTI spread options. On Friday we saw aggressively sized trade group selling in the WTI CSO 1Q’18 flat call collecting 12 cents and would look to sell those calls against owning the 1Q’18 -50 put which settled 9 cents on Thursday.

US producer data tightened last week beginning with a 100k bpd w/w drop in output to 9.25m bpd due at least partially to hurricane outages in the Gulf of Mexico. Alaskan output declined by 45k bpd and lower 48 output declined by 55k bpd. US oil rigs declined by 2 last week from a 25-month high to 756 and producer/merchant short positions continue to shrink due to lower prices. As one-off items none of these data points are particularly powerful but if production and rigs continue to decline and signal meaningful US producer stress due to lower prices it should provide a potent source of support to oil.

Funds go wayyyy too short

Speculators were aggressive sellers of NYMEX WTI + ICE BRENT again last week shedding net length by a total of 115k contracts (24% of net length). ICE Brent net length currently stands at an 18-month low of 229k contracts while NYMEX WTI net length at 135k is at an 11-month low. Funds added 48k in gross short positions last week bringing the combined gross short to 335k contracts which is 1.75 standard deviations above its 2yr average.

Funds were also net sellers of refined products last week bringing the net short position in RBOB to 21k contracts and the net short in heating oil to 27k contracts. The combined net short between the two contracts of 48k is the largest in at least two years. ETF flows continue to head in the opposite direction of COT data and the USO experienced a weekly inflow last week $88 million. Inflows into the ETF have totaled $583m over the last four weeks.

Option skew continues to show bullish interest

Prompt month WTI volatility moved lower across the skew this week aside from 10-delta call options which found a bid on speculative call buying. In late trading Thursday WTI U17 25d puts implied 29.7% vol while 25d calls implied 29% vol. The skew of less than 1% was the most bullish shape we’ve seen in the options market in months. Further back in the curve WTI M18 25d puts traded at a 5.5-vol premium to 25d calls and PEMEX was believed to be active hedging on the $39 strike for Dec ’17 – Nov ’18 maturities which should continue to drive deferred put skew in the coming weeks. Realized volatility (20-day) and implied vols were in line this week near 29%. 

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EIA data continues to disappoint

• Wednesday’s crude oil stats showed a seasonally abnormal 118k bbl build driven by PADD III despite modest imports into the USGC

• US crude production fell 100k bpd to 9.25m bpd due to a 45k bpd drop in Alaska and a 55k bpd drop in the lower 48. We still think that a decline in US output would be the most potent potential bullish catalyst in the market but last week’s data was obviously skewed by hurricane activity in the Gulf of Mexico.

• Weak US gasoline demand (-2% y/y) also persisted as a key feature of the bear market


US crude stocks added 118k bbls w/w and are higher y/y by 2.7% over the last month. By region, PADD I added 1m bbls and is +2% y/y, PADD II stocks fell 964k bbls and are +5.4% y/y and PADD III inventories are +3.2% y/y following a 1.2m bbl build. Cushing inventories fell by 297k bbls to 60.8m bbls and are lower by 7.6m bbls over the last nine weeks. US imports printed 8m bpd and are +3% y/y with PADD II imports +15% y/y and PADD III imports -7% y/y over the last month. Exports marked 528k bpd and are higher y/y by 13%.

US refiner demand fell for the third time in the last four weeks to 16.9m bpd and is higher y/y by 4% over the last month despite a 600k bpd drop from its peak in late May. By region, PADD I demand is +1% y/y, PADD II demand is +5.6% y/y and PADD III demand is +5.4% y/y. Crack margins continued to strengthen across markets this week with WTI 321 trading near $16.75/bbl while gasoil/brent is trading $10.50/bbl. For east coast refiners RBOB/brent traded $14.70/bbl. Related: Oil Prices Are Set To Post Worst H1 Since 1998

US gasoline data was somewhat better than expected this week leading with an overall draw of 894k bbls. PADD I stocks added 597k bbls and are -6% y/y, PADD II stocks fell 611k bbls and are +3% y/y while PADD III inventories are +5.5% y/y following a 453k bbl draw. In the mid-Atlantic PADD IB inventories were roughly flat w/w at 34.7m bbls and are lower y/y by 4.4%. On the demand side US gasoline consumption printed 9.5m bpd and is -1.8% y/y over the last month while exports at 662k bpd are higher y/y by 68%. Combined domestic demand + exports are roughly flat y/y.

Distillate demand was also slightly better than expected this week with an overall inventory draw of 223k bbls bringing stocks to a 1% y/y surplus. In the mid Atlantic PADD IB stocks fell 420k bbls and are flat y/y by while PADD II inventories are +6% and PADD III stocks are +8.7% y/y. On the demand side, US distillate exports printed 1.4m bpd and are +6% y/y over the last month while domestic demand printed 4m bpd and is +1% y/y.

Bonus Charts

By SCS Commodities Corp.

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