Oil Fundamentals Remain Bearish Despite Bullish Headlines

Oil prices got a variety of bullish headlines early this week as US/Iran tensions continued to boil, there was a modest thaw in US/China trade relations and the ECB president told reports he's ready to cut rates if necessary. OPEC+ also made headlines by making steps towards cementing a supply cut extension in July.

On the Iran front, this weekend's attacks on oil tankers in the Gulf of Oman are understood by US intelligence to have come at the hand of Iran-linked personnel. Secretary of State Mike Pompeo and National Security Advisor John Bolton have both publicly made hawkish comments towards Iran and the Iranians, in turn, have stated they will begin to enrich uranium at higher levels than what the JCPOA would have allowed. President Trump, meanwhile, has hinted that he will not hesitate to send additional troops to the Middle East to neutralize further Iranian aggression while also noting that he, in no way, wants to seek war with Iran (and batted down John Bolton in doing so.) He also described the oil tanker attacks as 'very minor.' While a path to a major US/Iran conflict still appears murky, it does seem that both sides seem to be locked in a destructive cycle of antagonization then reaction which makes a path to a cease in hostilities equally murky. For now, it's hard to say much more than that this is a critical oil market situation which we need to continue to monitor.

As for US/China, Donald Trump sent stock markets soaring suggesting that he will have an extensive meeting with Xi next week at the Japan-hosted G20. This was the first reason for optimism on US/China trade relations in several weeks and sent the S&P 500 to a 6-week high while Shanghai Composite held on to recent gains. While a near term trade deal might be unlikely after two months of bickering, we still think that Trump would prefer to make some sort of deal with China that he can brag about on the campaign trail next year in a similar fashion to how he declared a trade victory with Mexico despite no real changes in policy. Further complicating issues is China's media which has taken an increasingly anti-American path in order to drum up support for Xi in his 'fight' with trump.

On the central bank front, ECB President Mario Draghi told reporters that his central bank stands ready with additional stimulus if global trade weakens while US traders are pricing in a rate cut from the US Fed later today. For all the talk of central bank stimulus helping risk assets, it's worth noting that on a relative basis the US Fed has taken a more hawkish stance than many of their peers and the strength in the US Dollar has certainly been bearish for oil. Don't look for that to change this week as markets are already expecting the Fed to loosen rates a bit.

Lost in the shuffle of this week's news are the continued bearish fundamentals which are currently keeping a lid on prices. OPEC+ has fought extremely hard to balance the market so far this year and failed miserably with US crude inventories higher by more than 45m bbls in 2019. As we noted last week, perhaps the best reason to be bullish the market at the moment is that hedge funds, banks and trading groups all seem to be positioning in an extremely bearish posture where a contrarian bet could pay nicely. Going forward, more bullish headlines will be nice. Actual inventory draws would be better.

Quick Hits

- Brent crude rebounded to near $62.50 this week with help from the aforementioned Iran, US/China, ECB and OPEC+ headlines. Brent futures are still lower by about $8 over the last month.

- We've done our best to cover the soggy state of US crude fundamentals this year and we illustrate this trend with a chart of the prompt 1-month WTI spread which is now in contango. This week a surge of barrels into the Cushing delivery hub put pressure on spreads.

- OPEC+ appears to be close to finally agreeing on the date of their next meeting. It looks like the cartel will join forces in Vienna on July 1st and 2nd. We still expect the group to reach a short term bargain to extend their current production cut regime. On a longer horizon, however, we think that the massive difference in Russian v. Saudi budgetary needs for crude oil could ultimately make it hard for the two sides to cooperate.

- The US is sending 1,000 additional troops into the Middle East in order to help contain recent aggression from Iran. Iran still completely rejects they had anything to do with the attacks.

- Prompt brent spreads are actually moving lower this week despite the US/Iran tension suggesting physical traders don't see any supply shocks in the near term.

- Hedge funds continue to dump oil contracts at an extremely aggressive pace. Speculators cut net length in Brent to 292k contracts last week - down 28% since early May and cut net length in NYMEX WTI derivatives to 129k for a 53% cut since early May.

- The recent calm in oil prices has run slightly in contrast to some panicky geopolitical headlines. Options markets are not ignoring the heightened potential for volatility with the NYMEX/CBOE WTI volatility index rallying to nearly 50% this week.

- Meanwhile, in equity markets, recent rallies have the VIX subdued.

DOE Wrap Up

- US crude oil production moved slightly lower last week to 12.3m bpd and is averaging 12.1m bpd so far in 2019 after averaging 10.8m bpd in 2018.

- The continually high output helped generate yet another crude oil stock build this time for about 1.8m bbls. Overall crude stocks stand at 485.5m bbls and are higher y/y by 11% over the last four-week period.

- The US currently has 28.8 days of supply of crude oil on hand which is 15% higher than the same point last year.

- Crude stocks are also ballooning in the Cushing trading hub and keeping a lid on WTI spreads. Cushing inventories jumped more than 2m bbls last week to 52.9m which is their highest mark since December of '17.

- Traders imported 7.6m bpd last week and exported 3.1m bpd for a net balance of 4.5m bpd of imports. Net imports have averaged 4.2m bpd so far in 2019.

- US refiners processed 17.1m bpd last week and have averaged 16.43m bpd of demand so far in 2019 which is lower y/y/ by about 230k.

- US gasoline stocks climbed about 800k bbls last week to 234.9m and have increased by more than 6m bbls over the last four weeks. Overall gasoline stocks are slightly lower y/y.

- US distillate fuel inventories fell by about 1m bbls last week and are higher y/y by about 10% over the last four week period.

- US gasoline demand + exports printed 10.4m bpd last week and are averaging 10.1m bpd over the last four weeks which is flat y/y. US gasoline consumption is lower y/y by 75k bpd so far in 2019.