As investors and market commentators we must always be asking ourselves- what are we missing? This is true when we’re correct on the market and our position is winning. Obviously, it’s true when we’re wrong on the market as well. We’ve been asking ourselves ‘what are we missing?’ a bunch in the last four weeks as Brent crude moved from $75 to $70 despite a.) continued OPEC+ cuts and increased odds of a deal extension in June, b.) an unexpected end to the US waiver program on Iranian crude which has effectively banned the nation’s oil from the global market and c.) the increased threat of hostilities between the US, Saudi Arabia and Iran.
It’s obvious to point to the collapse of the US/China trade deal as keeping a lid on oil prices. After all, global stock markets are sharply lower in May and government bond yields have moved lower as investors have rushed for safety while Washington and Beijing seemed to move farther from a deal than ever. Can’t we just point to US/China relations as the sole cause of oil’s drop? Well, maybe. But it’s always necessary to keep digging for a less obvious trend and it’s wise to keep abreast of lurking risk in the market. On that note, we were particularly interested in an oil-focused piece recently released by the Federal Reserve Bank of Dallas which was focused on the link between crude prices and the break-even prices at the US’s hottest shale producing region.
The piece- titled Breakeven Oil Prices Underscore Shale’s Impact on the Market- reviews the relationship between oil prices and the breakeven price of production for US oil companies (with break evens defined by an informal survey of oil companies.) The two authors illustrate that prompt WTI prices have deviated from the Dallas Fed breakeven price by a maximum of $15 going back to 2016 and ultimately concludes “this (the proliferation of shale oil) does not rule out the possibility of major oil price movements, but it does point to a strong tendency that oil prices will be range-bound in the near future.” While the range of factors that can have a short-term impact on crude oil is infinite, it’s important to remember that long term commodity prices are anchored by the marginal cost of supply. Right now, the world’s marginal supply source is in Texas, and the cost of that supply is right near $50. With WTI trading near $60 and Brent near $70, its therefore reasonable to think that US production activities can help alleviate further upside risk in the market. Let’s agree to keep an eye on this trend if WTI rises to $65 and see if the “$15 Rule” can hold.
Beyond West Texas, flooding near the Cushing trading hub put a bid on oil prices this week while continued US/China tensions moved equities lower. In European politics, far-right politics continue to gain ground but moderate parties kept a comfortable majority. Meanwhile, hedge funds are dumping oil, but Brent spreads are predicting an extremely tight market in the second half of the year.
- Crude oil was essentially flat this week with Brent crude near $70/bbl while WTI traded $59/bbl. Brent is up about $15 so far in 2019 but lower by more than $5 from its high on April 25th.
- We’re increasingly interested in watching Brent spreads rally as flat price stutters. The prompt 6-month Brent spread traded backwardated by more than 70-cents per month this week suggesting physical traders are having a difficult time sourcing barrels. This shouldn’t come as a surprise to anyone with an internet connection as news flow on Iran and OPEC+ has been extremely bullish. However, this is an odd trend to watch opposite the weakness in flat price. At some point Brent spreads will have to move lower or flat price will have to move higher. The two are completely disjointed at present.
- US gasoline spreads were also particularly in the last few weeks suggesting tight supplies despite a lag in demand.
- Speaking of Iran, Bloomberg’s tanker tracker sees less and less the nation’s exports at sea. The tool currently identifies 38 Iranian ships in the Persian Gulf, 2 near Indonesia and about 4 between Shanghai and Hong Kong.
- Hedge funds were net sellers of ICE Brent futures and options last week for the second straight week. Speculators also sold NYMEX WTI paper for the fourth straight week. Both grades are now positioned in bearish territory with ICE Brent net length 18% below its 2yr average while NYMEX WTI net length is 3% below its 2yr average.
- President Trump rejected the anti-Iran narrative of his national security advisor this week telling Japan’s Prime Minister that “we are not looking for regime change. I just want to make that clear.” Trump also told reporters that US is not ready to make a trade deal with China.
- A Chinese government researcher presented a paper this week predicting the US/China trade war will last until 2035. Remember when it looked as if the two sides would ink a deal in May? I guess we won’t be so lucky.
- Equity markets were mixed this week. US stocks were generally softer and made new 1-month lows, the Shanghai Composite and European markets were broadly flat.
- The Euro sank against the USD with the pair back below 1.12.
DOE Wrap Up
- Last week’s DOE reports served traders yet another bearish gold mine. In summary, we saw seasonally abnormal inventory builds and more weak demand across crude oil and refined products. Fundamental data like this will almost guarantee that OPEC+ extends its current agreement through the second half of 2019.
- US crude production moved higher by 100k bpd to 12.2m bpd last week and just 100k bpd below its all-time high.
- US crude inventories shot higher by more than 4.5m bbls to 467m and are higher y/y by 8% over the last month. Crude stocks in the Cushing, OK delivery hub also increased by more than 1m bbls to 49m.
- The US currently has 28.9 days of supply of crude oil on hand, its highest mark of 2019.
- The increase in inventories came despite a sharp drop in imports from 7.6m bpd to 7.0m bpd. Exports declined by about 400k bpd to 2.9m bpd.
- US refiner demand fell 100k bpd to 16.6m bpd and is lower y/y by 50k bpd y/y over the last four weeks. US refining margins are reasonably healthy near $23/bbl.
- US gasoline stocks jumped by about 3.7m bbls to 229m but are still lower y/y/ by about 3%.
- US gasoline domestic demand + exports totaled 9.85m bpd last week and is lower y/y by 150k bpd over the last four weeks.
- US distillate stocks jumped by about 750k bbls last week to 126.4m and are higher y/y by about 8%.