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Matt Smith

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Oil Prices Edge Lower As Gulf Of Mexico Storm Fears Abate

As the dollar rallies again, as Gulf of Mexico storm fears dissipate, and as a build is expected from tomorrow's EIA report, crude is heading lower once more. Hark, here are five things to consider in oil markets today:

1) Strong Northwest European gasoline imports into the U.S. East Coast in Q2 helped PADD1 gasoline inventories rise to their highest level since at least 1990 (when records began), and to a 20 percent surplus to last year's level. June imports from the region were a key contributor to the growing gasoline glut, up 73 kbd versus the prior year.

As imports from this region have dropped off in August (see chart from our ClipperData below), this has helped gasoline inventories to ease lower. That said, East Coast inventories are still 14 percent (or 8.7 million bbls) higher than last year's level.

(Click to enlarge)

2) Staying on the topic of U.S. inventories, the chart below illustrates the extreme excess in terms of inventory levels for both crude and gasoline over the last year and a half.

While crude's surplus to year-ago levels reached nearly 30 percent late last year, this excess has now narrowed closer to half that (but is still a monstrous 73 million barrels higher, mind you).

But as refinery runs have held close to year-ago levels for much of 2016, the inability of the U.S. consumer to absorb this product supplied has meant that gasoline inventories have been gradually increasing their surplus to year-ago levels so far this year. Looking ahead, both should remain at a surplus to year-ago levels - but the extent of which will be dictated by the depth of maintenance season:

(Click to enlarge)

3) According to Wood Mackenzie, last year saw the smallest volume of oil discoveries since 1947, with 2.7 billion barrels of new supply discovered. This is about a tenth of the average seen since 1960. Even worse, this year is on course to be considerably below that; only 736 million barrels of oil have been discovered through the first seven months of this year.

As global capex for exploration has been slashed from $100 billion in 2014 to $40 billion this year, oil discoveries have dropped to a seventy-year low.:

(Click to enlarge)

4) We noted a few weeks ago how it is useful to keep an eye on Mexico's oil hedging strategy, given how shrewd they have been in the past. Hence, after hedging its exposure last year at $76/bbl, and at $49/bbl this year, they have now completed their hedging program for 2017 - at $42/bbl.

The Mexican government has hedged 250 million barrels of oil using put options, through 46 transactions with seven counterparties. The government spends ~$1 billion to put these derivatives in place, but just as last year illustrated, a windfall of $6.3 billion can be achieved through this pursuit of risk management and price certainty. For 2017, Mexico has hedged its largest volume since 2009.

(Click to enlarge)

5) With tropical activity picking up as we head towards the ultimate peak of hurricane season (hark, September 10), the latest disturbance - aka tropical depression nine - has caused 11 percent of Gulf of Mexico oil production to be shut in (168 kbd), as six production platforms have been evacuated as a precautionary measure. Even though TD9 is set to peel away from Gulf of Mexico oil infrastructure in the coming days and make landfall across western Florida, it is a reminder of how production can be affected.

While natural gas production in the U.S. Gulf has been marginalized due to cheaper, more prolific shale gas production onshore, GoM oil production is still an integral part of the picture. While natural gas production in the GoM has dropped from around 25 percent of total domestic production some 15 years ago to less than 5 percent now, oil production is around 20 percent, with production close to 1.7 million bpd according to our ClipperData production model, and rising as new projects come online.

By Matt Smith

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