Russia’s Shadow Hangs Over Oil Markets

Last week's note had a geopolitical focus as we laid out why we think Donald Trump will have an outsized impact on oil prices this Spring. Our theory here is that Trump's decisions on waivers for buyers of sanctioned Iranian crude and a potential US/China trade deal will be the two most important events for traders to watch.

This week things got slightly more interesting in terms of geopolitical risk as Russia sent a chill down the spine of crude oil bulls by questioning their commitment to the OPEC+ pact. To summarize, Russia's Finance Minister gave prepared remarks over the weekend which sewed doubt into the idea they'll continue to hold hands with OPEC to shrink global crude inventories. The Minister even mentioned a desire to fight for market share against US producers. For fun, he added that the odds of a global recession are elevated and that Russia's streamlined budget was well prepared to manage such an event taking a shot at their fiscally-strained ally Saudi Arabia. Two days later, Vladimir Putin cryptically pledged support for the production decreases but conceded that the oil market is rapidly changing, and they may have to change course as circumstances dictate. Our view is that $70 Brent almost fully prices-in an extension of the existing production cuts, so any interruption to this baseline market assumption could
have aggressively bearish consequences in the coming months.

Do these comments mean that a production cut extension is now unlikely? Probably not. We still think that Russia and the Saudi's will ultimately come to a mutually beneficial deal to extend production cuts. Saudi Arabia has been extremely disciplined in their desire to tighten the markets and still needs higher prices to balance their budget. On the other side, Russia is obviously benefitting from the boost in prices and was likely just reminding their geopolitical peers that they have significant clout in moving oil markets. This is a classic Putin-style show of influence and a reminder to his allies and opponents alike that Russia will have an influential role on the global stage.

Away from Moscow, unplanned supply outages persist as a key provider of upside risk in the market. This week oil traders continued to rapidly lose barrels from Libya, Venezuela and Iran. We still think the Trump Administration will eventually grant waivers to key Iranian buyers in order to calm global prices, but the Libyan situation looks increasingly nasty to us. This week the Wall Street Journal and Washington Post reported that Libyan warlord Khalifa Haftar rejected a recent peace deal and launched a violent assault in the nation's capital at the behest of Saudi Arabia and Russia. The proxy nature of this war could make it increasingly difficult to resolve.

Downside risks have also endured, however, and we were interested to see the head of the IEA state last week that he's increasingly concerned about the current lack of global oil demand growth in the market. The organization currently sees global demand growth near 1.4m bpd in 2019, but alerted traders to the possibility this could get revised lower. We weren't surprised to see this highlighted as a risk given that US refiner demand is lower y/y by an incredible 780k bpd y/y over the last five-week period. Bullish risks continue to lurk, but we remain confident in the idea that economic soft spots will limit the potential of near-term rallies. We're even more confident of this view in light of Russia's decision to make OPEC play the waiting game before signing up for another round of supply cuts.

Quick Hits

- Oil prices are slightly higher this week with Brent trending towards $72/bbl while WTI traded $64/bbl. Oil remains as a top performer for risk assets in 2019 with WTI +40% YTD while Brent is higher by 33%.

- For comparison, the S&P 500 is higher by 16% so far this year

- The US Dollar Index continues to flatline near 97.00. Early in 2019 we expected some USD movement to transmit volatility into oil as central banks generally put rates on a lower path and in some cases increased their balance sheets. Instead, currencies have remained flat and mostly been a non-story for oil over the last two months.

- Crude oil option traders continue to pay a premium for downside risk versus upside risk. This week the WTI 25-delta put expiring in May priced at 26% volatility while the 25-delta call priced at 23% volatility. The difference was even sharper on 'wingy' options with 10-delta puts implying 30% vol while 10-delta calls traded 23%. While we can't know exactly what's on the mind of every put buyer and call seller, it's clear that traders are more eager to buy downside protection than upside protection.

- Hedge funds are still buying oil. Last week's CoT report showed managed money as net buyers of 10k ICE Brent futures and options contracts and net buyers of 30k NYMEX WTI futures and options. Combined, net length between the two contracts is +140% in 2019 including a 40% bump in the last five weeks. On a bullish note, however, net length does not appear to be overstretched and is well within its 5yr range suggesting more length could easily be added if circumstances invite bullish positioning.

- Bloomberg reported on the difficulty selling Iranian barrels this week. The country has offered 6m bbls on its electronic oil exchange this year and was able to move only 35k bbls. The news agency also noted that Asian buying of Iranian barrels has almost completely ceased this month as countries wait for more clarity regarding US policy. Our expectation is still that the US will have to grant waivers to Iran's largest customers in order to keep a lid on prices. Trump loves to have a bearish influence on gasoline prices and this would likely be an opportunity he can't pass on.

- Analysts believe that Chevron's deal to buy Anadarko will position the company as the leading producer of US shale oil. Anadarko has significant holdings in the Permian Basin which has been largely responsible for this year's surge in US production.

DOE Wrap Up

- US crude production was flat last week at 12.2m bpd and is averaging 12.0m bpd so far in 2019.

- Heightened crude output helped generate a 7m bbl w/w increase in overall US crude stocks. US crude inventories stand at 457m bbls and are higher y/y by 4% over the last five weeks.

- On a more bullish note, crude stocks in the Cushing, OK delivery hub fell 1.1m bbls to 46m giving some bullish relief to WTI spreads.

- The US currently has 28.5 days of crude oil supply available which is higher y/y by about 3 days.

- US traders imported 6.6m bpd of crude last week showing further tightening of OPEC- and particularly Saudi- barrels. The US has imported an average of 6.7m bpd of oil over the last five weeks after averaging 7.8m bpd of imports in 2018.

- US crude exports fell sharply last week to 2.3m bpd- roughly 400k bpd below their 2019 average.

- US refiner demand printed 16.1m bpd representing a 150k bpd w/w improvement. Unfortunately, refiner runs are down an incredible 780k bpd y/y over the last five weeks. Refiner demand is down 200k bpd so far in 2019 versus last year. We continue to view this trend as astonishingly bearish.

- On a brighter note, refining margins continue to improve as the WTI 321 crack strengthened to $22/bbl this week for its highest seasonal mark in three years.

- US gasoline inventories fell sharply yet again last week with a 7.8m bbl draw. Overall gasoline stocks stand at 229m bbls and are lower y/y by about 1% over the last four-week period.

- US distillate fuel inventories were flat last week at 128m bbls and are flat y/y over the last month.