• WTI fell from $47 to under $43.40 through Thursday this week with help from a strong USD, growing fatigue among market participants about OPEC’s production ceiling talk and, of course, stubbornly poor refiner demand, weak refining margins, high levels of existing supplies and above forecast output from OPEC, Russia and the U.S. In the near term we are maintaining fair value for WTI in a $42-$50 range and would look to own call spreads for WTI Z16 or Brent F17 on further weakness in flat price.
• The EUR/USD’s drop from a Friday high of 1.1341 to a weekly low of 1.1204 played a key role in oil’s recent losses. Looking ahead, we think the most critical event for the oil market in the near term is the U.S. jobs data for August which will shape attitudes on the odds of a rate hike in September. As of Thursday afternoon Fed fund futures implied a 24 percent chance of a 25 bp hike in September and bond yields have reflected higher odds of a benchmark increase with the U.S. 2yr yield moving from 0.53 percent on July 5th to 0.78 percent at the end of the day on Sept. 1st. Should jobs data prove unexpectedly strong and drive USD strength / crude oil weakness we would look to buy WTI Z16 $47/$52 call spreads paying $1.20 (current value near $1.40, expires Nov 16th) believing that tighter crude oil spreads and falling product stocks in major hubs show evidence of a market still moving towards supply/demand balance. We also expect the $40 area to invite significant speculative length into the market as evidenced by the market’s reaction to July’s selloff.
• Exhibits A, B and C for our argument above would be drops in PADD IB gasoline, ARA Gasoil and Singapore distillates of 9 percent, 7 percent and 11 percent, respectively over the last five weeks. In our minds this is revealing that poor refining margins are causing sharp refiner input decreases and will eventually lead to tight products strengthening the entire complex. ARA gasoil and Singapore distillates are already at y/y deficits as our charts illustrate. We also think it is also important to note that prompt spreads in Brent (37-cents contango) and WTI (60-cents contango) are at or near their highest levels since early July and are behaving as if the market is tightening despite the drop in flat price. Prompt WTI spreads were particularly sensitive to the upside this week following a 1m bbl draw in Cushing and the loss of about 300k bpd of output for several days in the Gulf of Mexico due to Hermine. In conclusion, we think that global product inventories and crude oil spreads continue to reveal a tightening global oil market and would use any dip to the $40 mark for WTI as a buying opportunity with a 1-2 month horizon.
Front WTI spreads tighten on Cushing draw, GoM outtages
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In U.S. markets traders began last Friday with a flat rig count at 406 which broke a streak of ten straight weeks of increases. U.S. crude production fell 60k bpd to 8.49m bpd but PADD II crude imports (+5 percent y/y) continue to apply pressure to spreads. On the bullish side, Hermine shut GoM production this week to the tune of 240k bpd – 360k bpd which represents about 1/6 to 1/5 of GoM output. PBF joined Delta this week in publicly discussing sharp run cuts at an east coast facility (Delaware City) due to abysmal margins.
WTI 1-2 moved sharply higher this week following the aforementioned production outages due to Hermine and Cushing’s second 1m bbl draw in the last five weeks. The front spread traded up to -0.56 on Thursday for its highest print since July 8th. In the back of the curve things were a bit softer with WTI Z16/Z17 moving to -4.06 on Thursday for a 60-cent loss since last week.
OPEC leaders up the ante on production ceiling talk but traders aren’t buying it
Overseas, analysts and newswires have begun estimating August output data for OPEC lead by JBC Energy which believes the cartel’s output decreased by 125k bpd m/m to 33.2m. Reuters estimated OPEC’s August output at 33.5m bpd for a modest gain versus July at 33.46m bpd. JBC believes that Nigeria lead declines seeing their output fall 80k bpd m/m from 1.51m bpd to 1.43m bpd. This week was a good example of the long road ahead for Nigeria’s output recovery efforts as rebel group attacks on a production facility were reported just a few days after the Niger Delta Avengers stated they had reached a ceasefire deal with the government.
On Tuesday Iraq’s PM said the country would support measures to freeze output near current levels while also stating their need to keep growing production to fix the country’s tenous finances. JBC estimated Iraqi output at 4.3m bpd in August for a 50k bpd m/m decline. Iran’s deputy minister of industry estimated his country’s current output level in August at 3.8m bpd and said that country aims to increase output to at least 4m bpd by year-end. Bloomberg’s Tanker Tracker estimated Iranian exports at 2.16m bpd in August which represents a post-sanctions high. Saudi Oil Minister Al-Falih told news outlets that he doesn’t see a need for the kingdom to grow their exports with the market already oversupplied but preliminary forecasts (via Reuters) for Saudi output in August are as high as 10.9m bpd after pumping a then-record high of 10.67m bpd in July. Saudi Arabia’s minister of foreign affairs told reporters on Thursday that “if other producers were to agree (to production limits) it is reasonable to expect Saudi Arabia to go along with it.” These comments were met with deffening silence from traders who continued to push oil lower in sharp contrast to last week when Iranian ceiling-talk forced a rapid short cover rally. As for Libya, JBC estimated their August output at 320k bpd up from 300k bpd in July. Bloomberg reported stoppage at Libya’s Wafa field (35k bpd) after armed guards arrived seeking payment from the NOC. JBC also estimated Venezuelan output at 2.13m bpd down from 2.18m bpd in July. Russian oil minister Alexander Novak noted on Thursday that he sees no need for an output freeze with prices near the $50 mark.
Brent spreads followed WTI this week by moving higher in the front of the curve while deferred spreads corrected lower. Brent 1-2 traded to a weekly high of -0.34 on Thursday for a 36-cent rally since July 12th while Brent Z16/Z17 sold off to -3.75.
Fund short covering brings net length to near 2016-high, ETF outlflows reach $471 million over last two weeks
COT data unsurprisingly revealed more mass short covering for the week ended August 23rd after crude oil peaked on the 29th. For NYMEX WTI net length nearly tripled to 244k contracts in just four weeks as gross short positions were cut in half. For ICE Brent net length grew from 260k to 386k in the same four week period as gross shorts were cut by more than 75k contracts. We continue to believe that bearish market sentiment will reveal itself through new gross shorts in the round of data ended August 30th.
Refined products data for the week ended August 23rd was also bullish due to short covering as RBOB net length jumped to 15k and Heating Oil net length jumped to 22k. USO outflows have reached $470 million over the last two weeks which is the largest outflow of any two week period this year.
Option markets unchanged, puts remain bid while demand for calls is minimal
Option premiums were generally unchanged on a w/w basis with WTI Z16 50 deltia implied volatilityt at 37 percent, 25 delta puts at 42 percent and 25 delta calls at 35 percent. As has been the case for the last four weeks, wingy 5 delta calls continue to trade at a discount to 50 delta options which to us remains a harshly bearish signal of current market sentiment. Realized volatility for crude oil moved slightly higher this week to 36 percent and the CBOE/NYMEX WTI volatility index jumped to 38 percent for an increase of 3 percent since August 25th.
Bearish DOEs feature surprise crude oil build, more weak demand numbers
• Overall crude oil stocks added 2.3m bbls due mostly to a 2.9m bbl build in the US Gulf
• On the bullish side Cushing stocks dipped 1m bbls and production fell yet again with lower 48 production -50k bpd w/w
• Refiner inputs fell 64k bpd w/w and utilization is lower by 2 percent y/y over the last four weeks, gasoline demand fell 148k bpd. Last year’s drop in refiner demand from August to October was 1.3m bpd which will weigh on market strength this fall.
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Total U.S. crude stocks added 2.3m bbls w/w and are higher y/y by 16 percent at 526m bbls. PADD II stocks fell 1.4m bbls (+8 percent y/y,) PADD III stocks added 2.9m bbls (+22 percent y/y) and Cushing stocks fell by 1m bbls to 63.9m bbls. Crude oil imports jumped 275k bpd after PADD II imports increased by 424k bpd and PADD III imports fell by 236k bpd. Overall imports at 8.9m bpd are higher y/y by 11 percent. PADD II imports are higher y/y by 5 percent and PADD III imports are higher y/y by 14 percent. US crude production fell to 8.49m bpd which is 60k bpd above its YTD low.
The U.S. refiner demand picture continues to look bleak due to poor margins. This week’s data included a w/w drop of 64k bpd in inputs. Overall inputs are lower y/y by 0.1 percent over the last four weeks lead by a drop of 11 percent y/y in PADD I. Crack margins moved lower this week with the WTI 321 crack dropping to $12.80, LLS 321 at $10.50 and Gasoil/Brent at $8.80. Refiner utilization at 92.8 percent is lower y/y by 2 percent.
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Gasoline supply data was bullish this week, led by a 2.2m bbl draw out of PADD IB to bring the northeast surplus down to 17 percent y/y. Overall mogas stocks fell 691k bbls and are higher y/y by 8 percent. PADD II stocks added 1.5m bbls this week (+5 percent y/y) and PADD III stocks added 555k bbls (+6.7 percent y/y.) Gasoline production was roughly flat w/w at 3.3m bpd and is higher y/y by 2 percent. Domestic demand fell 148k bpd to 9.5m bpd (+0.8 percent y/y over last four weeks) and exports at 549k bpd are higher y/y by 31 percent.
RBOB futures moved sharply lower this week hitting the $1.28/gl mark for the first time since August 11th. In spread markets RBOB Z16/Z17 moved lower to the -3.80 area but is still more than 4 cpg higher than its July low and remains in a technical up trend.
Distillate data was considered bearish this week beginng with a 1.5m bbl overall build (+3 percent y/y) lead by a 1.6m bbl build in PADD I. PADD IB stocks added 512k bbls and are higher y/y by 6 percent. Distillate production at 4.97m bpd is higher y/y by 1 percent. Domestic demand increased 48k bpd to 3.84m bpd (+2 percent y/y) and exports at 1.05m bpd are lower y/y by 14 percent.
Heating oil futures moved lower this week in line with the rest of the complex and prompt futures traded from a high of $1.50 cpg on Tuesday to $1.41 cpg by Thursday morning for a 12-day low. Spread markets weakend with HO Z16/Z17 moving from -8.5 cpg to -10.5 cpg.
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By SCS Commodities
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