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Refiner Pain And Macro Economic Fear Drive Crude Lower

Oil refinery

• Markets are a little bit stressed at the moment. Last week’s digestion of Britain’s EU rejection included a record low print in the US 10yr yield at 1.318% opposite a near-record close in S&Ps, a $1,375 print in gold for the first time since March, a 30yr low in the GPB/USD below 1.30 and the yield on the Swiss 50yr bond turned negative. Reactions to last week’s FOMC minutes and significantly above forecast U.S. payroll gains for June were muted as investors seem completely entrenched in their expectations of central bank support from the U.S., Europe, Japan and China regardless of minor shifts in economic data.

• As for oil, traders also took a more gloomy interpretation of news flow, which mostly included continuations of old trends (aside from unexpectedly high Nigerian output) including onerously high gasoline and crude oil stocks and extremely poor refining margins. The most recent focus for newswires was subpar margins eating into run rates (most notably on the U.S. east coast) but we’d argue that bloated product stocks in every major storage hub, weak refiner margins and refiner demand that is solid but not good enough onto clear the overhang of global crude inventories aren’t really news at all. Most importantly, the expected surge in gasoline demand this summer and its ensuing virtuous cycle have yet to arrive and bullish traders seem to be losing their nerve. Lost in the shuffle of last week’s selloff were the largest w/w decline in U.S. output since 2013 and an increasingly tenuous situation in Venezuela, which could remove around 250k bpd by year-end with trader’s focusing their attention on bearish news items.

• The manic macro environment and a more bearish outlook for oil have driven significant volatility for WTI over the last two weeks. In the ten trading days ending on July 7th, WTI’s average daily high/low range reached $2.20 - its highest since January 2015 - while realized volatility (20-day basis) climbed to 50%. Compared to the mostly range bound implied volatility that WTI U16 options are pricing at (39%-43% last week) we continue to see good value in owning short dated put and call spreads to express directional views in the market. We’d argue that traders will continue to have to settle for singles and doubles, however, with a $45-$50 range still our most likely scenario for crude.

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Weak refiner outlook pushes spreads to 5-month lows

Last week’s U.S. producer data included an increase of 10 rigs to 351 (13-week high) which continues to put pressure on WTI structure despite a continued fall in production. The most recent round of EIA data put U.S. output at 8.428m bpd, which is its lowest level since May 2014 and has removed about 1.1m bpd from the market from the April 2015 peak of 9.69m bpd.

Nevertheless, we continue to see a flattening rig count as having a powerful psycholigical impact on the market’s ability to conceieve a sharp rally anytime in the next 12 months. Canada’s output is believed to have made a full recovery back to pre-wildfire levels as of last week while the rig count north of the border increased by 5 w/w to 81. Related: Could Helium Help Canada Recover From The Oil Bust?

For prompt WTI structure the strength of the rig count in addition to the aforementioned oversupply of virtually each component of the barrel have helped weaken WTI U16/Z16 from a high mark of -0.75 in May to a low of -1.85 last week. Another key component of the spread’s weakness was news of refiner output cuts (highly unusual given where we are on the calendar) in the NJ/PA area due to multi-year lows in the RBOB/Brent crack, which we would only expect to accelerate going forward as more refiners use poor margins to rationalize extended shifts into fall maintenance. Spreads were also weak further back on the board with WTI Z16/Z17 closing near -3.75 Friday from a high of -0.50 in May.

Overseas, news from Nigeria and Libya continued to dictate moves in Brent spreads on the way to their lowest levels since February. In Nigeria, cease fire agreements between the Nigerian government and the Niger Delta Avengers added to bearish pressure, which was interrupted by more attacks from the NDA and a labor strike. Bloomberg estimated Nigerian production at 1.53m bpd in June for an improvement of 90k bpd m/m. Libya was a key source of pressure for Brent spreads after news emerged that its Es Sider and Ras Lanuf (its 2nd and 3rd largest export facilities, respectively) will reopen in the next two weeks for the first time since 2014. In the Middle East, Saudi output for June jumped 70k bpd which was negated by an equal drop in Iraq while Iranian production was flat m/m at 3.5m bpd. Venezuelan production was also flat at 2.33m bpd and overall OPEC production at 32.88m bpd was higher by 240k bpd.

The ramification of the above data for Brent structure was heavy speculative selling from trade groups and funds predicting that heightened OPEC output opposite weak demand in China and Europe could make for a very ugly end to the summer with refiners seemingly eager to cut back production. For U16/Z16 brent this meant a weekly low of -1.79 for a $1.15 loss since May 16th. Brent Z16/Z17’s low of -4.40 marked a roughly $3 loss since June 8th.

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Crude options move sideways opposite large underlying moves

Oil markets had several sharp moves last week including a $3 drop in about 2 hours in Wednesday following DOE stats which were unable to meet the high expectations set by a bullish API report. In the ten trading days ending July 7th crude oil’s avg. daily high/low range was $2.20 - its highest since January 2015 and realized volatility jumped over 50% on Wednesday (up from about 19% one month ago.) Aside from some momentary bidding up of puts, however, WTI’s skew remained mostly unchanged and implied volatility was unimpressed by the increasingly loud shifts in flat price. Late last week WTI U16 25 delta puts traded at 44% implied while 25 delta calls traded 37%. At the money options for WTI U16 traded at 39.7%. In our view the steep discount in implied versus realized volatility in crude options at a time of extremely high macro strain continue to make them an attractive value to express directional bets.

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Fund positioning grows increasingly bearish

COT data for the week ended July 5th revealed hedge funds as net sellers of NYMEX WTI for the sixth time in the last seven weeks and during that span net length has dropped by 32%. Gross length has been cut by 7% over the last two months while gross shorts have increased by 125%. In products, RBOB net length held by funds has dropped to 1,500 contracts - down from 34k in March - while net length in heating oil has jumped to 18k.

On the commercial side, producer/merchant’s net short has decreased to 261k from as high as 295k in April. In ETFs the USO enjoyed about $70m in net inflows from June 17th through July 1st.

Another mediocre DOE report sends crude oil reeling

• Crude oil stocks continue to decline at a reasonable pace relative to seasonal norms but refiner demand has been essentially flat y/y due to poor crack margins

• Gasoline, distillate gluts continue in major hubs from New York to Europe to Singapore

• On the supply side, U.S. crude production fell nearly 200k bpd (largest weekly decline in output since October 2013), which went largely overlooked as bearish sentiment drove the market’s response

U.S. crude inventories fell by 2.2m bbls w/w due to large draws in PADDs I, II and V. PADD IIs draw of 1.4m bbls was due largely to a 101k bpd drop in imports from north of the boarder. In PADD III stocks grew by 1.3m bbls following a 786k bpd increase in imports in the USGC. Overall crude oil stocks are higher y/y by 12.6% and Cushing stocks dropped by 82k bbls.

Refiner inputs dipped slightly w/w, which is unimpressive given our location in the calendar. Over the last four weeks demand has averaged 16.55m bpd, which is just a 70k bpd improvement. Unsurprisingly, poor crack margins have been blamed for the tepid refiner data as WTI 321, gasoil/brent and RBOB/brent have all continued to trade at multi-year seasonal lows. Related: Why Did China Grossly Overpay For A Utility In Brazil?


Gasoline data was slightly below expectations with an overall draw of 122k bbls. Unfortunately the draw did little to slow extremely bearish sentiment as PADD IB’s draw still left the hub in a 23% y/y surplus. PADD I imports fell to 680k bpd but are still higher y/y by 5% over the last month. Overall mogas stocks are higher y/y by 9.6%. Domestic demand at 9.6m bpd is higher y/y by 2.5%.

Prompt RBOB futures moved sharply lower this week and made a 4-month low at $1.35/gl on both Thursday and Friday to cap a 30-cent drop since June 22nd. Spread markets were equally negative with RBOB Q16/U16 moving to contract lows on Thursday at -1.70 cpg.

Overall distillate stocks enjoyed a surprise draw last week and are higher y/y by 8.4%. Unfortunately, PADD IB added another 683k bbls to bring the mid Atlantic higher y/y by 23%. At least some of the build on the east coast seemed to be due to a 36k bpd increase in imports. As for demand, domestic distillate consumption fell 65k bpd to 3.93m bpd and is higher y/y by 1.5% over the last month. Exports at 1.3m bpd are higher y/y by 5.5%.

Heating oil futures moved to 2-month lows this week and broke below $1.40/gl after the level had served as a solid support in June and earlier in July. Spread markets revealed expectations of more poor fundamentals ahead for distillates with Heating Oil Q16/U16 moving to contract lows before -2.50 cpg on Friday.

Overseas, prompt gasoil spreads continued to crumble this week on continued oversupply. As of Friday afternoon Gasoil Q16/U16 trade to -$7/t for a new contract low following larger than expected inventory builds in both Amsterdam /Rotterdam / Antwerp and Singapore.

(Click to enlarge)

By SCS Commodities

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