Futures Are Signaling An Oil Market Rebound

Friday February 17, 2016

In the latest edition of the Numbers Report, we’ll take a look at some of the most interesting figures put out this week in the energy sector. Each week we’ll dig into some data and provide a bit of explanation on what drives the numbers.

Let’s take a look.

1. Currency problems cutting into India’s oil demand

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- A plan to cut down corruption by taking high-valued notes out of circulation is backfiring on the Indian economy. Since most transactions are conducted in cash, the policy is disrupting economic activity.
- India’s oil demand plunged by 4.5 percent in January from a year earlier. Both gasoline and diesel consumption fell sharply.
- The issue is not merely a domestic problem, but it will have an effect on global markets. India imports 80 percent of the oil it needs and India is taking over from China as the world’s largest source of demand growth, a mantle it is expected to hold through 2040.
- Any slowdown in Indian demand could cut into global demand figures.

2. Futures market says supply deficit looming

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- The oil futures market shows signs of ongoing concerns about oversupply, but only until the middle of this year.
- For the near-term, futures are in a state of contango, suggesting a glut will persist for several months. But the contango disappears on futures beyond mid-2017, a reflection of investor expectations that the market will dip into a supply deficit.
- The timespreads also indicate that investors expect inventories to start drawing down substantially from June on.
- The timespreads fly in the face of many projections about inventory declines much sooner. The IEA expected inventories to fall by about 0.6 million barrels per day between January and June, a prediction that is looking less likely.

3. Asia refined fuels glut

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- Refiners have made a massive bet on demand for fuels such as diesel and gasoline in Asia for years to come, but the market is suddenly looking dangerously oversupplied.
- Chinese demand is unexpectedly slowing down just as a lot of refineries have come online. The result is a huge buildup in refined fuels, a glut that some believe could take years to clear.
- BMI Research estimates that gasoline and diesel production in Asia will exceed demand by about 750,000 barrels per day in 2017, or 5 percent of annual consumption in Asia. The supply overhang could continue through 2021.
- The glut is crushing refining margins, which have plunged to just $6.50 per barrel.
- Companies are bailing on projects as a result. For example, Saudi Aramco recently pulled out of $20 billion refining joint venture in Malaysia due to poor economics.
- “We really don’t need one more giant refining complex” in Asia, said Nelson Wang, energy analyst at CLSA in Hong Kong, according to the WSJ. “Many of these projects were proposed four or five years ago. That’s a lot of lead time, and the oil market is really different from five years ago.”

4. Saudi Arabia shaving its summer demand peaks

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- Saudi Arabia has already started to cut down on its peak consumption in summer months by burning natural gas instead of oil for electricity.
- A new gas project came online last year that helped displace the equivalent of Ireland’s daily crude demand, as the WSJ put it.
- The Saudis are also turning to solar – they plan on building 10 GW of solar by 2023, which could reduce consumption by another 80,000 bpd. Taken together, the gas and solar projects could displace all crude consumption in winter months, according to Wood Mackenzie.
- The efforts to cut down on demand would deliver multiple benefits: it would free up more oil for export, improve the government’s fiscal position and also diversify the economy.
- But it also is one more source of additional supply onto the global market.

5. Oil speculators testing the limits of optimism

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- Hedge funds and other money managers continue to pile into bullish bets on crude oil, with net-long positions hitting new record highs almost every week.
- Speculators staked out a net 865 million barrels of oil on rising prices, a bullish position that grew 78 percent since the OPEC deal.
- While investors have pushed net-longs to new heights, they can’t defy gravity forever.
- What makes the downside risk particularly acute is that oil prices have not even rallied much this year, having hovered in the $50s since the OPEC deal.
- “If crude prices are to break out of their recent range in the next few weeks, the risk is to the downside," JBC Energy GmbH in Vienna told Bloomberg.

6. Trading mystery in U.S. on inventory reports

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- The FT reported on a mysterious trading phenomenon that has taken place for much of this year. Every week the EIA puts out reports on changes in crude oil inventories. Inventories have ticked up for consecutive weeks in 2017, sometimes by large amounts.
- Typically, that is a very bearish sign of oversupply, which, one would think, should push down oil prices.
- However, a trading pattern has emerged in the oil markets – after falling initially on the EIA reports, prices quickly rise only minutes later.
- The reason is that somebody has been making very large purchases of positions on crude immediately after the report.
- There are various theories on who is doing the buying – hedge funds trying to defend their bullish bets; OPEC trying to protect oil prices – but so far it is a mystery.
- Oil traders have picked up a trading practice: “buy the builds,” referring to betting on rising prices when there is a bearish EIA report on inventory builds.

7. Eagle Ford finally rebounds

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- The Eagle Ford was one of the earliest and fastest growing sources of shale oil production, with output surging beginning in 2011.
- But the South Texas shale play has been hit hard by the downturn in oil prices. Rig counts vanished, spending dried up and drillers went elsewhere.
- However, things could be on the rebound. The EIA sees shale output rising by 14,000 bpd in March, a small volume, but a psychologically important turning point for the basin.
- The stabilization of oil prices in the $50s per barrel is helping various shale plays rebound this year. Also, the red-hot Permian basin is seeing land prices skyrocket, leading to spillover effects – drillers are looking elsewhere for bargains and the Eagle Ford is benefitting.
- U.S. oil production is already up 400,000 bpd from last summer. If shale output is to rise substantially this year, the Eagle Ford will be a major reason why.

That’s it for this week’s Numbers Report. Thanks for reading, and we’ll see you next week.