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Expert Commentary: The Weak Spots In The Oil Price Rally

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• Oil bulls were all smiles this past weekend when non-OPEC producers lead by Russia agreed to cut production by more than 550k bpd for a six-month term beginning in January. The announcement was complimented by Saudi comments that the Kingdom was eager to take a leadership role in bringing total OPEC production down to 32.5m bpd and may even cut more production than they had agreed to in order to pull the physical oil market into balance. Unfortunately, Sunday’s early print of $54.51 would prove to be the high mark of the week as weakness in Cushing, bearish developments in Libya and a relentlessly strong USD ended the rally and pulled prompt WTI back down towards last week’s lows below $50.

• In its market report released this week the IEA estimated that- if enacted- the agreed to production cuts from OPEC and non-OPEC nations would create a supply deficit in the market of 600k bpd in the first half of 2017. This, of course, is a very big ‘if’ and we are continuing with our $47-$55 medium term outlook for crude oil despite the bullish deal making of the past two weeks. While recent agreements have obviously reduced downside risk for oil, our view of current market sentiment is that traders will wait to see concrete evidence of aggressive supply cuts before oil has a chance to trade +$60.

• One of the fundamental developments we see limiting upside risk in the short term is the aggressive increase in US production over the last few months. Following recent estimate revisions, the EIA now sees US crude production at 8.796m bpd for an improvement from its summer low of 368k bpd. Beyond merely helping to bearishly shift sentiment, the response from shale producers is adding a significant amount of crude oil to the market relative to this summer and seems unlikely to slow given the massive amount of producer hedging that occurred opposite WTI Calendar 2017’s run to $57 last week.

• More positively, we did see encouraging signs of market performance this week in the form of improved DOE stats which have now shown a 7m bbl crude oil draw in the last two weeks in addition to sharp demand recoveries for gasoline and distillates. Prompt brent spreads also managed to maintain their bullish trend despite news the Libya had reopened a field > terminal pipeline with capacity of +300k bpd.

(Click to enlarge)

Cushing builds and Libyan pipeline reopen hit the pause button on spread strength

WTI G17/H17 traded in a wide 31 cent range this week peaking on Monday at -0.70 following the agreement on non-OPEC output cuts and reaching a low -1.01 as cash rolls traded down to -1.40 and Cushing suffered a 2nd straight large weekly build which brought stocks in the hub to 66.5m bbls. Deffered spreads also weakend slightly with M17/Z17 trading from a weekly high of +10 cents backwardation to a low of 60 cents contango on Thursday. Spread option markets saw rened bearish interest this week with trade groups and funds aggressively bidding puts in WTI F/G and WTI 2H17

US producer data has been unanimously bearish in the last week. To begin, US production reached just under 8.8m bpd for its highest print since May and an increase of 368k bpd since its July low at 8.428m bpd. The increased production has come with help from an increase in the rig count to 498 representing a 58 percent jump since May. Recent rallies in Cal ’17 and Cal ’18 WTI strips to +$56 has lead to an increase in producer hedging and brought the NYMEX producer/merchant gross short position to six year high.

US diff market excitement was focused in the Bakken this week where Bakken-WTI spiked to -75 for a $2.25 rally in the last two weeks (unsure of the catalyst here.) Midland-WTI also traded at strong levels printing +$1.05 Thursday afternoon with trade groups still busily buying up barrels for export. In WTI-Brent arbs the H17 contract managed to slightly beat its low print from last week and briefly spiked to -1.50 on Tuesday before moving back towards -1.75on Thursday. on Thursday. Related: Combatting Cyber-Attacks In The Oil And Gas Industry

Prompt brent spreads traded choppily this week in an ultimately flat trend which held on to recent gains. The week’s low print in Brent G17/H17 at -77 came following news that Libya had reopened two pipelines with capacity of 300k-400k bpd to its Zawiya refinery and export terminal. This dip was enthusiastically bought, however, and the spread moved up to -64 cents in early trading on Thursday. Further back in Cal ’17 Brent M17/Z17 traded into backwardation on Monday and Tuesday with a high print of +11 cents before correction to a weekly low of -52 on Thursday.

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Speculators go way long, USO liquidation continues

COT data for the week ended December 6th revealed speculators as massive buyers of NYMEX WTI and ICE Brent contracts. In NYMEX WTI net length increased by 81k contracts for a 43 percent w/w increase in length. In ICE Brent net length increased by 142k contracts for a 46 percent w/w increase in length. The two contracts’ combined addition of 223k contracts in net length was the largest w/w increase on record. More than half of the addition to net length came from liquidation of short positions which (65k for NYMEX WTI, 60k for ICE Brent) totaled 125k.

Data for NYMEX refined products followed a similar trend with RBOB net length held by speculators nearly doubling in a jump from 22k to 40k. In Heating Oil net length almost tripled in a jump from 9k to 24k. This shift in market sentiment remained in sharp contrast to ETF flows as the USO experienced a w/w outflow of $197m (for the week ended December 9th) bringing the two week total for outflows to $565m.

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Option premiums flattening out at low levels

WTI H17 vol was mostly quiet in the 31 percent-33 percent area this week aside from a momentary jump on Wednesday which coincided with steep FX moves following the Fed’s rate decision. As of Thursday morning WTI H17 50d options priced at 32 percent while 25 delta puts priced at 36 percent and 25 delta calls implied 30 percent. The NYMEX/CBOE WTI index sank below 30 percent for the first time since June 2015 on Tuesday. Realized volatility (20 day basis) was steady near 50 percent.

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EIAs improve, still have work to do

• US crude inventories enjoyed another w/w draw and have declined by about 7m bbls over the last two weeks. Unfortunately the draw was PADD III-driven and included another Cushing build. Stocks in the hub have increased by 5m bbls in the last two weeks.

• US crude output jumped sharply to 8.796m bpd for a seven month high. Production has increased by more than 350k bpd since its July nadir.

• In refined products inventory changes were more bullish than expected and demand had a signficant w/w pickup Related: How Vision 2030 Will Transform The Oil World

US crude stocks fell by 2.6m bbls w/w due largely to a 2.3m bbl w/w draw in PADD III and are now higher y/y by 5.4 percent. In PADD II inventories fell 213k bbls (+6 percent y/y,) PADD III’s draw brought USGC inventories to a 7 percent y/y surplus and in Cushing inventories increased by 1.2m bbls to 66.5m bbls which is their highest level since June. PADD I and PADD II both reported sharp drops in w/w imports bringing overall imports down 943k bpd w/w to 7.4m bpd.

US refiner inputs still look disappointing to us after a small w/w increase to 16.5m bpd. Overall inputs are lower y/y by 1.3 percent over the last four weeks and are still about 300k bpd lower than their December peak in 2015. Utilization is currently at 90.5 percent which is lower y/y by 2.5 percent. US refining margins are still mostly in line with seasonal norms with the WTI 321 crack near $14/bbl this week while gasoil/brent at $11/bbl leaves room for improvement in Europe.

Gasoline stocks added 497k bbls w/w (+4.9 percent y/y) due mostly to a 1.6m bbl build in PADD I which brought east coast stocks to a 7.5 percent y/y surplus. PADD IB stocks were essentially flat w/w at 31.6m bbls and are still higher y/y by 14 percent. PADD II inventories are +6 percent y/y following a 600k bbl build and PADD III stocks are higher y/y by 6 percent following a 1.7m bbl draw. Domestic demand jumped more than 100k bpd to 8.9m bpd but is still lower y/y by 3.8 percent over the last four weeks. Gasoline exports increased to 1.1m bpd and are higher y/y by 83 percent.


(Click to enlarge)

Gasoline futures traded to new post-Colonial highs this week briefly touching $1.59/gl on Monday then selling off towards $1.54/gl on Thursday. Spread markets maintained their recently bullish trends with RBOB M17/Z17 trading up to +24 cpg.

Distillate inventories managed a w/w draw of 762k bbls bringing overall stocks to a y/y surplus of just 2.6 percent. PADD IB inventories increased by 363k bbls (+5.9 percent y/y,) PADD II inventories fell by 988k bbls w/w (+3 percent w/w) and PADD III distillates were flat w/w and higher by 1 percent y/y. Production at 5m bpd is lower y/y by 2 percent. On the demand side distillates saw bullish data for the first time in more than a month with domestic consumption increasing more than 300k bpd w/w to 4m bpd. Distillate exports at 1.3m bpd are higher y/y by 1 percent.

Heating oil futures made new 2016-highs this week with a peak at $1.71/gl before moderating to $1.65/gl by Thursday afternoon. Spread markets behaved similarly with HO M17/Z17 briefly trading over -4 cpg before falling back to -4.5 cpg.

Overseas refined product data was mostly bullish this week and included steep w/w draws in Amsterdam-Rotterdam-Antwerp gasoil stocks as well as distillate inventories in Singapore. In ARA gasoil stocks fell 75k mt w/w to their lowest seasonal level since 2013 and are lower y/y by 32 percent. Further east, Singapore’s distillate inventories fell by 3.3m bbls w/w and are now lower y/y by 13 percent. Gasoil M17/Z17 has responded in kind by trading up to -8.25 for the first time since June 2015.

(Click to enlarge)

By SCS Commodities Corp.

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Leave a comment
  • Kr55 on December 16 2016 said:
    Not seeing any mention of the 4 mega-projects that were coming online this year, mostly in the last part of the year, in the gulf of mexico. Projects planned 3+ years ago that were too far along to be cancelled after the price crash. Looks like they have come online now based on the EIA production data.
  • Joe on December 16 2016 said:
    You mentioned that "Cushing suffered a 2nd weekly build" . I believe this is no different from tanker loads of oil sitting in Singapore harbour. Why would someone be anxious to sell the oil if they expected a better price with time. Tank rentals in Cushing are cheap compared to tanker rentals in Singapore. Might as well expect Cushing inventories to climb. It used to be a sign of surplus oil but now it's a sign of antipated higher prices.

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