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Oil Volatility To Increase During Brexit Week

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• Brexit anxiety dominated markets this week after new polls revealed heightened odds of a Leave vote. From June 9th to June 16th, the GBP weakened considerably and the EUR/USD sank from over 1.14 to below 1.113. The EUR/USD drop dragged WTI Q16 from $52.28 to $46.68 despite a supportive supply/demand forecast from the IEA, a steep drop in U.S. output and continued issues in Nigeria, Canada and Libya. We think that oil’s recent weakness has been almost entirely driven by FX as we attempt to illustrate with our chart below

• As of Thursday there seemed to be coin-toss odds of Britain voting to leave the EU next week. We maintain our medium term neutral-to-bearish outlook for the oil market, but feel the current FX/weak crude dynamic presents a compelling selloff to buy via tight call option spreads that could pay up to 4:1 if Britain votes to stay (our hunch is they will,) the USD takes a dive and crude oil is able to resume its 4-month momentum rally on increasingly rosy fundamental expectations. While we aren’t dogmatically bullish on oil in the medium term horizon, we see good value in being long the WTI Q16 $50/$54 call spread paying $0.70, expecting the trade to earn about $3.00 if Britain votes ‘stay.’ The Fed’s newly dovish outlook for rates and GDP growth from Wednesday’s meeting should also add a tailwind to this trade.

• Bond markets were exceptionally strong this week as investors fled risk and aggressively bought safe haven assets. The U.S. 10yr yield settled below 1.57 percent for the first time this year and the Germany 10yr yield actually fell to -2 bps after beginning the year near 0.6 percent. Wednesday’s FOMC meeting didn’t include a rate hike and showed more modest expectations for growth and rate increases in 2016, with six members saying they now expect only one rate hike this year- a highly dovish shift since this winter when only one ‘dot’ fell on the 1-hike line. Odds of a July hike dropped to about 12 percent.

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Spreads stay weak due to Iranian exports, surprise Cushing build

The prompt 1-month WTI spread shot higher to begin the week on bullish Genscape data for Cushing and continued disruptions in Canada. Unfortunately, Wednesday’s DOE report revealed a surprise 904k bbl build in the hub which helped start a reversal in time spreads through Cal ’16. WTI U16/Z16 sold off to a weekly low of -1.34 for an 80-cent selloff since its peak in March. New estimates from Canadian producers suggest that output will begin ramping back up in late June. PADD II imports slowed to 2.04m bpd this week after peaking at 2.7m bpd in April. In 1q16 PADD II imports averaged 2.51m bpd. U.S. production fell by 29k bpd w/w and the U.S. rig count is flat over the last five weeks which we continue to feel has a meaningful impact on sentiment even if U.S. production has yet to bottom out. We continue to see risk for 4Q16 WTI spreads as skewed to the downside and would look to sell moves into the -0.20 area (for 1-month spreads) as seasonal record high crude stocks persist heading into what could be an ugly turnaround period for U.S. refiners given the 5+ year lows in crack margins.

In Brent, the prompt 1-month spread sold off to -0.60 and is lower by 40 cents since April. Brent U16/Z16 also moved lower to -1.14 and is weaker by 50-cents since its May peak. OPEC released its Monthly Oil Market Report this week and left global supply and demand forecasts unchanged for 2016, seeing a closer to balanced market later this year. The IEA also released its oil outlook this week seeing a balanced market in 2h16 before additional production from core OPEC members tilts the market into surplus in 1h17. Reuters estimates suggest that Iranian exports will reach a 4.5 year high in June at 2.3m bpd after averaging 2.2m bpd in May. Nigeria, Libya and Latin America production issues continued to make headlines this week but Brexit talk also contributed to weakness in the front of the curve for both WTI and Brent.

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Hedge funds and producers still stuck in neutral

Last week’s CoT data showed hedge funds still sitting on their hands. In WTI, net length decreased slightly to 322k which is virtually flat since March. During that time both gross short and long positions have jumped by about 10k contracts. In Brent, net length was flat at 389k which is unmoved since April. On the producer/merchant side net shorts in NYMEX WTI fell slightly to 270k while the ICE Brent net short dropped to 742k.

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FX, equity volume drive crude option premiums higher

Option markets enjoyed a healthy bounce with WTI Q16 at-the-money implied volume jumping from 33 percent to 39 percent w/w. Skew also widened on crude oil’s move lower with 25 delta puts pricing at a 5 percent premium to calls (42 percent / 37 percent.) Most of the jump in crude oil volatility was transmitted from option-buying in FX and equities as EUR/USD 1-month volume rallied from 9 percent to over 13.5 percent and the VIX ran from 13.0 to 22.0. Realized volatility remained near a 2 year low at 22 percent which makes option premiums at almost double that level seem rich. Our assumption is that volatility will remain elevated through next week’s Brexit vote after which the recently dovish Fed meeting should help calm things down. Related: Oil Continues To Tumble On Brexit Fears

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DOE report shows mixed inventory, demand data

• Cushing unexpectedly added bbls for the fifth time in seven weeks, overall crude stocks drew 933k bbls which was underwhelming against expectations of a large draw. U.S. production fell 29k bpd.

• Domestic mogas demand had a strong w/w jump (+2.9 percent y/y over the last month) but U.S. refiner demand unexpectedly fell, continuing an unimpressive month of inputs.

• Gasoline stocks fell 2.6m bbls but PADD IB inventories were flat w/w

Wednesday’s stats began with an overall crude stock draw of 933k bbls which brought overall stocks to a 14 percent y/y surplus. PADD I was by far the tightest region of the week with a 1.7m bbl draw. East coast crude stocks are flat y/y. PADD II stocks fell 129k bbls (+11 percent y/y,) PADD III stocks fell 24k bbls (+16.8 percent y/y) and Cushing stocks added 904k bbls against expectations of a roughly 1m bbl draw. Inventories in the hub currently stand at 66.5m bbls. U.S. production fell 29k bpd to 8.7m bpd which was a relief to oil market bulls following five weeks of flat rig-count data. Crude imports fell 83k bpd to 7.6m bpd and are higher y/y by 9.8 percent. Imports from Nigeria and Canada fell by 100k bpd and 307k bpd w/w, respectively, which was mostly compensated for by shipments from Venezuela and Angola.

US refiner demand took a seasonally abnormal turn lower w/w by 100k bpd to 16.3m bpd. Inputs are lower by 0.8 percent y/y over the last four weeks. The sharpest drops have come in PADDs II and III where inputs are down 1 percent and 1.2 percent y/y, respectively. PADD I demand at 1.2m bpd is higher by 0.7 percent y/y. Crack margins remain unimpressive with WTI 321 printing near $15/bbl while LLS 321 traded $9/bbl. Gasoil/brent yielded just $10/bbl.

Gasoline inventories fell by 2.6m bbls due to draws of 2.1m bbls and 1.6m bbls in PADDs II and V, respectively. Overall stocks are higher y/y by 9 percent. PADD IB stocks were flat w/w and are higher by 28 percent y/y. Gasoline production at 9.7m bpd is higher y/y by 1 percent. PADD I imports fell 100k bpd w/w to 686k bpd but are still higher by 39 percent y/y. Domestic gasoline demand jumped 194k bpd to 9.76m bpd and is higher y/y by 2.9 percent while exports at 374k bpd are lower y/y by 10 percent.

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(Click to enlarge)


RBOB flat price and spreads continued to move lower this week with N16 futures reaching a five-week low at $1.46/gl on Thursday. The prompt N16/Q16 spread found support on the -1.49 level on Wednesday but is still lower by a half a penny since late May. Related: Where Does Wall Street See Nuclear Energy Going?

Distillate inventories built by 786k bbls which is seasonally normal but doesn’t help ease the glut of product. Overall distillate stocks are higher y/y by 14 percent and PADD IB stocks are higher by 43 percent following a 1.75m bbl build. Exports at 1.2m bpd are higher y/y by 9 percent while domestic demand at 3.8m bbls is lower by 2.6 percent.

(Click to enlarge)

Heating oil futures also moved lower, dropping to $1.42/ gl to complete a 10-cent selloff since June 9th. N16/Q16 heat was mostly flat near -0.80. Further back in the curve U6/Z6 heating oil moved to -4.50. 

Prompt gasoil spreads also moved lower this week with N16/Q16 trading from -1.50 to -3.00. N16/Z16 moved from -10 $/t to -16.00. Singapore gasoil stocks increased by nearly 2m bbls this week and are higher y/y by 17 percent. ARA gasoil stocks decreased slightly w/w and are flat y/y after some seasonally abnormal draws from the European hub.

(Click to enlarge)

By SCS Commodities Corp

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