- 2Q’17 wasn’t supposed to go like this! Heading into the spring the broad consensus in the oil market was that aggressive global inventory draws would move WTI into the mid $50s and beyond. Unfortunately EIA data failed to deliver the bullish goods despite OPEC compliance near 100% due largely to output gains in the US, Canada, Libya and Nigeria. So here we are, back trading $43 and the physical rebalance + flat price rally narrative that held so much promise has spiraled into a George Costanza’s three month Yankee severance-like state of decay: But it was supposed to be the Summer of George!!!
- Where can a market in disarray find support now that the aggressive inventory draw story has at least temporarily lost its fastball? The most potent bullish trend for the market in our view would be a slowdown in U.S. production growth. The EIA sees U.S. production at 10m bpd in 2018 but the estimate is based on an average 2018 WTI price of $54/bbl (the Cal ’18 WTI swap is currently trading $45.) We think that sub $44 oil and steepening futures curve could slow the increase in U.S. rigs and generate headline-making credit stress for higher cost projects (see the spike in HY energy interest rates) - many of which still need +$50 WTI to make money despite rapid efficiency increases. Unfortunately on a longer horizon substantial flat price rallies will face a massive wall in the form of a fresh record high in U.S. drilled but uncompleted wells.
- In geopolitics we also aren’t counting OPEC out in its ability to manage downside risk for two reasons. Firstly, the cartel’s 1Q’17 revenues increased y/y despite production cuts providing an important lesson in cooperation. Secondly, the ARAMCO IPO persists as compelling motivation for Saudi-lead market management. On a longer time frame the cartel is obviously losing price influence to shale, but that doesn’t mean they can’t create headline risk in the near term (as they did this week) by floating discussions of more aggressive cuts.
- Lastly, we expect oil to find at least a small degree of support from short covering, technical buying (RSI and stochastics suggest oil is a conviction buy) and seasonally improved supply/demand data. Prompt WTI and brent spread contango near 20 cents / month forecast strong inventory draws in the coming months so perhaps the end is NOT near for oil.
- Away from the oil market we continue to have macro anxiety as lower yields and a flattening yield curve continue to signal serious global growth concerns. The US 10yr yield traded near 2.15% this week following a 7-month low print last week at 2.10% and several banks issued strategy notes in June offering serious concerns on consumer demand and credit creation including BofA which cut its 2018 U.S. GDP forecast from 2.5% to 2.1%. US gasoline demand + exports are higher by less than 1% y/y YTD which needs to improve in order to inspire bullish trading.
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Spreads stable despite surge in floating stocks
Brent U17/Z17 moved slightly higher this week (near -79 on Friday) despite steadily bearish news flow including a spike in Libyan production to +900k bpd and expectations that Forcados will export 250k bpd in June. Global floating crude stocks have also continued to spike from 155m bbls in April to 202m bbls this week and Bloomberg reported this week that BFOE floating storage in the North Sea is near a YTD high of 9m bbls. On the bullish side, Chinese exports for May jumped 15% m/m and 2h17 imports are expected to increase by 500k bpd y/y to 8.2m bpd by FGE Analysts after increasing by 12.5% y/y through April. Related: Is There Still Hope For Higher Oil Prices?
Back in the US, prompt WTI spreads steadied following three weeks of heavy losses with help from a drop in Cushing stocks to 61m bbls (down from 69m bbls in April.) US crude exports printed 517k bpd this week which was their lowest mark of 2017. Exports have averaged 759k bpd YTD but have failed to take pressure off of bloated storage facilities in PADD II and PADD III which continue to attract mass quantities of imports. In diff markets wti-midland was flat near -85 while wti-brent z17 was flat near -2.50.
Global prices have clearly fallen to producer-stress levels with large swaths of US and Canadian wells now dipping into unprofitable territory. Over the last four weeks we have seen small evidence of the stress with decreased producer hedging as NYMEX WTI + ICE BRENT producer + merchant shorts have declined by more than 100k contracts. The US rig count has yet to show stress though climbing last week for the 50th time in the last 55 weeks while production reached a 22-month high at 9.35m bpd.
Funds go from short to shorter
WTI NYMEX + ICE Brent net length held by funds had its largest w/w decline in five weeks in the week ended June 16th with net sell efforts of 26k and 24k contracts, respectively. Net length has been cut by 14% over the last two weeks and by 36% over the last nine weeks and is now slightly below its 2yr average for both contracts. Gross shorts have steadily climbed for both products and the 46k addition to shorts in NYMEX WTI and ICE Brent was the largest in five weeks.
Speculative flows for NYMEX RBOB and NYMEX Heating Oil were also aggressively bearish this week with net sales of 17k and 19k, respectively. The combined net sale of 36k was the largest bearish reposition in five weeks and the current combined net short between the two products of 37k contracts is the largest short position held in since November 2015. ETF flows continued to move opposite COT data last week and the USO enjoyed an inflow of $217m for a combined buy of $486m over the last two weeks.
Prompt call options rally on flat price collapse
Crude option vols were generally flat this week in the 29%-32% range which was consistent with last week’s action. Across the skew, however, there continues to be a noticeable bid for upside risk in prompt maturities as funds and trading groups have used the flat price carnage as an opportunity to buy upside risk on $45-$50 strikes. In the back of the curve hedging activity (PEMEX is expected to be active in the coming weeks) has maintained a 5% put skew on 25 delta options. Volatility seems fairly valued against 20-day realized vol which is also trending near 31% this week.
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When -2.5m bbls w/w just ain’t good enough
• Wednesday’s EIA data showed a better than expected 2.5m bbl draw. Crude enjoyed a short lived jump off the headline number followed by a sharp selloff as the market was once again reminded that US data needs to show substantial crude draws each week (+4m bbls minimum) in order to excite bulls
• The primary bearish issue in the US market is still above-forecast production. US output printed 9.35m bpd last week representing a 22-month high. Canada’s resurgent output- + 377k bpd y/y YTD through May- has also flooded the US market with oil. Imports from our neighbor up north have averaged 2.58m bpd in 2017 which is higher by 209k bpd y/y YTD.
US crude’s 2.5m bbl w/w draw brought stocks to a +1.8% y/y surplus. PADD I inventories are currently -6% y/y while PADD II stocks are +4% and PADD III stocks are +2.6% y/y. Crude imports printed 7.9m bpd last week and are +2% y/y with PADD II imports +17% y/y and PADD III imports -5% y/y over the last month. Partially to blame for the week’s disappointing headline crude draw was an export print of 517k bpd which was -200k bpd w/w. Cushing inventories continued to draw and fell to a 6-month low at 61.1m bbls. Related: Macquarie: OPEC Deal To Collapse In 2018
Like their producer friends, US refiners stayed busy this week processing 17.15m bpd following a weekly drop of 100k bpd. Overall refiner inputs are +5.7% y/y with PADD I demand -2%, PADD II demand +7.6% and PADD III inputs +7.3% y/y. Global crack margins were mostly stronger this week and should get some relief from bulging product stockpiles by the collapse in crude costs. Gasoil/brent traded $9.70/bbl late this week while the WTI 321 crack traded $16.40 and LLS 321 traded $11/bbl.
Gasoline data was also underwhelming this week with a headline inventory draw of 578k bbls bringing overall stocks to a 2% y/y surplus. In PADD IB inventories fell 283k bbls which puts mid Atlantic stocks -6% y/y over the last month and may continue to tighten after Bloomberg reported that Europe > US gasoline flows will reach a 3-week low next week. US gasoline demand + exports are roughly flat y/y and higher by less than 1% YTD despite a surge in exports to LatAm.
Distillate supplies printed a larger than expected w/w build of 1.1m bbls and are now flat y/y near 152m bbls. PADD IB inventories jumped 1.2m bbls on elevated imports and are -2% y/y while PADD II stocks are higher y/y by 6% and PADD III inventories are flat. Domestic distillate demand remains the star of the distillate complex at +6.6% y/y with a 4.2m bpd print last week. Exports continue to struggle and at 1m bpd are -13% y/y.
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By SCS Commodities Corp.
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