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OPEC Cuts Move West

drilling rig

- Crude oil’s bearish troubles in 2017 have largely been due to a lack of OECD inventory draws despite significant production cuts from OPEC + Russia. Several research firms and banks have pointed to stock draws in less ‘visible’ global storage (i.e. floating + middle east) and advised traders to patiently wait for this trend to move west where data is more robust.

- Wednesday’s EIA report hinted that the ‘OPEC effect’ could be moving west with an overall US crude draw of 5.3m bbls. The decline was driven by a 6.4m bbl draw in PADD III (the region’s largest w/w draw since December) due to a sharp drop in imports which had previously been a thorn in the side of WTI bulls. USGC floating inventories have also trended lower in recent weeks (Bloomberg estimates 3.9m bbls as of Wednesday) suggesting that the lack of imports may not be a weather-driven outlier.

- The most recent round of COT data revealed aggressively bearish positioning from funds which we think could be prone to short-covering if EIA data is able to deliver on expected stock draws again next week. ICE Brent managed money gross shorts were marked at 128k contracts as of May 2nd (nearly 1 standard deviation above its 3yr avg.) and funds hold net short positions in NYMEX RBOB and Heating Oil simultaneously for the first time since November 2015.

- We continue to have a positive view of flat price WTI at $48 believing sharp inventory draws (GS sees global draws of up to 2m bpd in July) will make sub $50 shorts tough to hold. However, we also see upside risks as somewhat limited without better developed market gasoline demand data. US gasoline demand + exports are only +0.7 percent YTD so far on a y/y basis. The lack of volatility in Cal ’17 WTI and brent spreads at modest contango levels also suggest fundamental limitations to a steep flat price rally.

- In recent notes we’ve also discussed macro reflation and growth concerns as a key bearish input for oil. This trend (at least expressed in markets) has enjoyed a turnaround over the last month with US rates and USD/JPY strengthening while copper found support on a liquidity injection effort from the PBoC, higher physical delivery premiums and a tighter forward curve. CME copper net length held by funds was cut by more than 60 percent from January to April but enjoyed its largest w/w bounce in14 weeks on a net-buy of 11k contracts.

Spreads find technical support, look to summer draws for rally

Calendar 2017 spreads both rallied sharply for WTI and brent this week eschewing production gains in the US and Libya in favor of impending inventory draws and a technical rebound after spreads had simply gone too deep into oversold territory. Diff markets also revealed some improvement despite Libyan output jumping to 796k bpd (NOC estimate) after reopening their +200k bpd Sharara field with DFL Brent trading to -68. Brent N17/Z17 rallied to a 1-mo high on Friday with an assist from comments from Saudi leadership that they ‘will do what it takes’ to balance the market. Related: Production Cuts vs Innovation – Why OPEC Has Lost The Oil Price War

Prompt WTI spreads also enjoyed a technical rally this week exacerbated by a modest w/w draw in Cushing of 438k bbls. By Friday afternoon WTI N17/Z17 rallied to -1.10 for a 37-cent rally on the week which certain trade groups faded by selling 4Q17 flat calls near 9-10 cents. In diff markets WTI was outpaced by Midland (Midland-WTI traded near -55 Friday) and Brent with the WTI-Brent arb falling to a 1-mo low at -2.67. Given the stunning rebound in Permian output we view Midland-WTI strength as an important indication that WTI spreads are not in imminent danger of collapse.

(Click to enlarge)

US production data was surprise-free this week and included an increase in the rig count while crude output jumped over 9.3m bpd for the first time since August 2015. Production is +886k bpd since its bottom in summer ’16 and within 296k bpd of its all time high reached in the summer of 2015. The Baker Hughes rig count jumped to 703 marking a 2yr high which suggests more upside room for US output. COT data showed a continued decline in producer/merchant short to 1.98m from a peak of 2.09m in February.

Funds go short RBOB, HO for the first time since November ‘15

COT data for the week ended May 2nd showed more bearish momentum from funds who cut NYMEX WTI net length by 20 percent w/w and cut ICE Brent net length by 10 percent w/w. Combined net length for both contracts has been cut by 30 percent over the last two weeks and is in line with its 2yr average at 525k contracts. Gross shorts between the two contracts have jumped 66 percent over the last two weeks and at 236k contracts is 25 percent above its 2yr average.

There was an interesting divergence this week between fast money flows in refined products and ETF flows in the USO. Hedge funds aggressively cut length in RBOB and Heating Oil contracts last week. So aggressively, in fact, they money managers went net-short in both contracts for the first time since November of 2015. The bearish sentiment was not shared by traders in the USO, however, as a weekly buy of $132m last week put the ETF’s two week inflow of $332- its highest since November.

DOEs show largest draw of 2017

- Wednesday’s stat report showed a 5.3m bbl w/w draw and the market finally got some hard evidence of OPEC cuts moving west
- PADD III crude stocks fell more than 6m bbls on a sharp decline in imports. Floating storage in the region has also declined sharply.
- On the bearish side refiner inputs fell sharply, gasoline demand was unimpressive and production topped 9.3m bpd

US crude inventories fell 5.3m bbls w/w and are higher y/y by 3 percent. PADD I stocks fell 1.5m bbls (-18 percent y/y,) PADD II stocks gained 1.9m bbls (+5 percent y/y,) PADD III stocks fell 6.4m bbls (+3 percent y/y) and Cushing inventories dropped 438k bbls to 66.3m bbls. Crude imports were the main driver of the w/w draw falling nealy 650k bpd to 7.6m bpd and are higher y/y by 5 percent over the last month. Exports also contributed to tighter stocks increasing to 693k bpd. Related: Why Goldman Thinks You Should Go Long On Oil

US refiner inputs declined sharply w/w from 17.2m bpd to 16.75m bpd but are still sharply higher than last year’s corresponding print and +6.3 percent y/y over the last four weeks. Utilization fell by 1.8 percent w/w to 91.5 percent and are +3.8 percent y/y over the last month. In refining margins gasoil/brent was firm this week near $9.25/bbl holding on to last week’s gains while the WTI 321 crack was slightly firmer near $16.80/bbl. In the USGC the LLS 321 crack traded near $10.70/bbl.

(Click to enlarge)

US gasoline stocks fell 150k bbls w/w with help from a 1m bbl decline in PADD II and 940k bbl decline in PADD III. PADD I stocks looked more bearish with an open arb into the east coast increasing imports into the region by more than 250k bpd w/w. PADD I gasoline imports are now +18 percent y/y. Overall gasoline stocks are currently flat y/y as are PADD IB inventories. PADD II stocks are +2 percent y/y and PADD III stocks are -5 percent y/y. Gasoline exports at 717k bpd are +74 percent y/y but domestic demand continues to perform poorly and is -2.6 percent y/y over the last month.

Distillate data was more supportive than gasoline stats showing an overall draw of 1.6m bbls which brought US inventories to a 4 percent y/y deficit. PADD IB stocks jumped 754k bbls to +1 percent y/y while PADD II inventories drew 720k bbls (+2 percent y/y) and PADD III supplied fell 640k bbls (-11 percent y/y.) Distillate exports continue to underpin strength in the complex printing 1.2m bbls this week and are higher y/y by 22 percent over the last month. Domestic distillate demand printed 4.1m bpd and is higher y/y by 3.1 percent.

By SCS Commodities Corp.

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