In sticking with our recent $42-$50 forecast for WTI we underestimated the ability of OPEC + Russia to talk the market up while behaving bearishly. Although recent production data for Libya, Nigeria, core OPEC and Russia has exceeded expectations by a significant margin the most powerful force in markets over the last two weeks has been a 154k contract increase (+34%) in speculative net length in ICE Brent and NYMEX WTI contracts as funds grew unwilling to hold short positions as long as rival OPEC members and Putin were publicly singing Kum ba yah. In our judgment the market is not fully pricing in meaningful shared supply cuts (and we don’t think it should be) but merely repositioning itself for the unlikely event that they occur.
More importantly, the bullish OPEC headlines are adding fuel to the rebalance narrative which we continue to see evidence of in rapidly falling refined product stocks in NY Harbor, ARA and Singapore which are already putting oil on a higher path. Over the last twelve weeks PADD IB mogas stocks have dropped by 29%, ARA gasoil stocks are lower by 12% and Singapore distillate stocks are lower by 18% (US distillate stocks have remained stubbornly high.) We expect these trends to persist as weak global refining margins exacerbate turnarounds (particularly in the US) and product demand continues to show modest y/y growth.
Heading into OPEC’s November 30th meeting we expect a range bound market for WTI from $47-$55 believing that the cartel has successfully raised the floor for oil while significant headwinds for an extended rally exist in the form of skepticism that a deal will be reached due to fiscal stress and geopolitical tensions, increased output from OPEC and Russia, flattening US output with more US producer green shoots in the form of increased hedging and rigs, high existing global inventories, shipments from new projects including the Kashagan field and lackluster forecast demand growth (IEA revised their global growth forecast down for the second straight month this week.) Our primary takeaway heading into the Vienna meeting is that if production cut discussions break down and provide a sharp selloff that WTI would be a conviction buy in the mid-low $40s due to our aforementioned belief in the fundamental rebalance and managed money’s eagerness to buy dips in the market.
(Click to enlarge)
With FX and rates pricing in a December hike we think macro risk for oil is to the upside
As of Friday morning Fed Fund futures saw a 74% chance of a rate hike at the FOMC’s December 14th meeting. Better than expected US economic data and measuredly hawkish statemends from Fed officials including this week’s release of of the September FOMC minutes have driven a signficantly stronger USD over the last two weeks with the EUR/USD dropping from over 1.12 to below 1.10 for the first time since July while the DXY rallied over 98.0 for the first time since March. The US 2yr yield has also jumped from less than 0.5% immediately following the Brexit vote to as high as 0.89% this Wednesday. Meanwhile, the uphill sledding of a stronger USD has been a testament to the conviction of oil’s current rally and something that could easily turn from a headwind to tailwind if momentum for the December rate hike slows and the Dollar weakens. We won’t opine on the likelihood of a rate hike actually occuring (or not) but with FX and rate markets pricing in higher rates its important for oil markets to consider the 1/4 odds of a steep decline in the USD should overnight rates stay flat through 2016.
WTI spreads rally through Z17 with help from supply disruptions and producer hedging
It was a difficult week to be short the WTI 1-2 spread. WTI’s prompt spread rallied as high as -0.32 this week to complete a 40-cent rally over the last month after protest groups vandalized five different Canada > US pipelines on Tuesday and Plains had to shut a 450k bpd Permian > Cushing pipeline for unplanned maintenance. Strength in WTI Z16/F17 to as high as -0.38 suggests that the pipeline issues could last at least several days which is consistent with what the operator reported to Reuters. WTI-Brent also strengthened on the outages to as little as -1.00 for a 3-month high.
Further back in the curve WTI M17/Z17 rallied up to -0.75 for the first time since June with help from US and Canadian producers who are increasingly feeling the love from OPEC and heding into a WTI Cal ’17 swap that traded over $54 this week for the first time since November 2015. As of October 4th the commercial/producer gross short position in NYMEX WTI had reached 592k contracts for its largest count since 2011.
(Click to enlarge)
Iraq, Libya push prompt brent spreads lower, back spreads still see supply/demand balance on the way
In brent spreads the front of the curve continued to move lower this week on optimism that export gains from Libya, Nigeria and Iraq were steady at least in the short term. Bloomberg reported that Libyan exports averaged 540k bpd over the last week after averaging 340k bpd in September and that a 460k bbl Aframax departed al-Hariga bound for Greece on Friday. Bloomberg also reported that Iraqi crude exports reached a record high of 3.97m bpd in the first two week of October. Brent Z16/H17 traded as low as -1.73 on Thursday for a roughly 75-cent loss since mid August. Brent M17/Z17 jumped above -1.00 for the first time since June with traders increasingly convinced that the clearing glut of oil will accelerate in the 2nd half of next year.
(Click to enlarge)
Fast and Real Money diverge on $50 oil
Different types of oil speculators have taken very different views on the OPEC + Russia production talk rally. For the hedge fund set that deals in NYMEX and ICE contracts traders have grown increasingly reluctant to hold short positions. Meanwhile real money players in ETF markets have liquidated length in the USO in significant volume. For NYMEX WTI, hedge funds had a massive addition to net length of 74k contracts (+41%) which was driven by a 43k liquidation of gross shorts (-30%.) In ICE Brent net length jumped by 69k contracts (23%) following a 28k contract liquidation of gross shorts (-30%.) Related: Are Market Conditions For U.S. LNG Improving?
In product markets funds’ love fest with RBOB endured with net length jumpoing to 31k. Funds also turned to a net long position in heating oil after going short for two weeks now holding net length of 6k contracts. In ETF land, however, investors have taken a much more skeptical view of the talk among OPEC + Russia. For the week ended October 7th outflows in the USO reached $283m which was the largest weekly outflow since mid Auugst and brought total outflows over the last two weeks to $347m. We are paying close attention to USO flows at the moment after they have made some seemingly prescient calls in 2016- buying oil for size on the low in February, fading the rally through the June peak, buying the July dip and selling the August rally.
Option markets still leaning bearish despite increased odds of an OPEC deal
(Click to enlarge)
Option premiums firmed slightly this week with WTI F17 at-the-money volatility increasing from 35% to 37% while the OIV index rallied as high as 39% for a 3% w/w jump. As for skew, 25d puts actually traded at a 6-vol premium to 25 delta calls for a an increase of 1% w/w despite the percieved higher odds of an OPEC deal coming to fruition by the end of November.
East coast imports drive first crude oil build since August
• US supplies jumped more than expected due to NJ/PA area refiner buying.
• PADD III stocks jump sharply on decreased refiner inputs but Cushing stocks fell by more than 1.3m bbls
• Refiner demand fell by 480k bpd to 15.6m and has about 200k bpd – 300k bpd more to drop before turnarounds are done
• Refined product inventories continue to highlight the crude oil fundemantal rebalance story with sharp declines in RBOB and Heating Oil stocks
US crude oil inventories added 4.85m bbls w/w and are higher y/y by 9% following builds of 3m bbls in PADD I (+21% y/y) and PADD III (+9.5% y/y.) US crude production fell slightly to 8.45m bpd (-7% y/y) and imports at 7.9m bpd are higher y/y by 9%.
US refiner demand continued to plummet in line with seasonal norms falling 480k bpd (-3%) w/w to 15.6m bpd. Overall inputs are still higher y/y by 2.4% and we estimate that runs will decrease by another 200k bpd – 300k bpd in the next 3-4 weeks before bottoming out. Crack margins were broadly lower this week including declines in RBOB/brent to $9.90/bbl and WTI 321 to $13/bbl which should help accelerate turnarounds and clean up product gluts over a longer horizon.
US refiner demand continued to plummet in line with seasonal norms falling 480k bpd (-3%) w/w to 15.6m bpd. Overall inputs are still higher y/y by 2.4% and we estimate that runs will decrease by another 200k bpd – 300k bpd in the next 3-4 weeks before bottoming out. Crack margins were broadly lower this week including declines in RBOB/brent to $9.90/bbl and WTI 321 to $13/bbl which should help accelerate turnarounds and clean up product gluts over a longer horizon. Related: The Truth About Permian Shale Break-Even Prices
Gasoline inventories fell by 1.9m bbls w/w to 225m bbls and are higher y/y by 2%. Inventories in PADDs II and III are higher y/y by 8% and 10%, respectively by PADD I inventories are now lower y/y by 9%. PADD IB inventories fell by more than 2.2m bbls and are lower y/y by more than 13%. Our assumption going forward is that decline refiner inputs will continue to help drive strong gasoline draws in the coming weeks. Domestic gasoline demand fell to 9.26m bpd and is higher y/y by 1.4%, exports at 805k bpd are higher y/y by 57%.
RBOB futures we modestly lowwer this week trading in a $1.50-$1.45/gl range. In spread markets Z16/H17 moved sharply lower to the -4.25 for a more than 2-cent loss over the last four weeks.
(Click to enlarge)
US distillate inventories fell by a larger than expected 3.7m bbls but are still higher y/y by 6%. PADD III was the driver of the draw with a 4.5m bbl weekly decline which we believe was export driven. Inventories in the USGC are lower y/y by 7.6%. PADD II distillates are higher y/y by 12%. PADD IB inventories are 9%. Domestic distillate demand enjoyed a jump of nearly 400k bpd to 4.3m bpd and is higher y/y by 18% over the last four weeks. Exports at 860k bpd are lower y/y by 36%.
Heating oil futures made a 2016-high on Monday at $1.6264/gl for a 35-cent rally since early August before selling off towards $1.56/gl later on Friday. Spread markets weakened sharply in the front of the curve with HO Z16/H17 falling to -4.30 cpg for a 1.5 cpg drop over the last two weeks.
By SCS Commodities Corp.
More Top Reads From Oilprice.com:
- Billions Of Barrels Of Undiscovered Oil May Lie Under Barents Sea
- Oil Prices Extremely Volatile After Massive Crude Build
- Gold Prices Just Did Something They Haven’t Done All Year