• After 3-4 weeks of waiting for oil to drop convincingly below $40 for a buying opportunity we seem to have missed the boat on this rally. We see prompt Brent trading choppily within a $45-$54 range in the coming weeks and if forced to pick a side believe the market is closer to being a sell than a buy following a $9 short cover / FX / OPEC jawbone rally with scant fundamental justification. Given our skepticism that a production agreement will be achieved in September (Iran probably won’t even attend) at OPEC’s informal gathering, the recent strengthening of the US production outlook, reports (via Reuters) that Saudi Arabia is set to improve on its record-setting output effort in July and sky-high crude and product inventories heading into peak refiner turnarounds we think that the current move higher for oil is starting to look rich. Option markets are also revealing unusually bearish sentiment as at-the-money calls in Brent Z16 are trading at higher implied volumes than 10 delta calls suggesting exceptionally weak demand for upside risk.
• If OPEC is able to continue to push speculative shorts out of the market leading up to its meeting in Algeria in September we would look to own put spreads- specifically the Brent F17 $51/$45 put spread (Nov. 25th expiration) on a move over $53 in Brent F17 futures. In terms of timing, while we feel that the market is close to losing its upside momentum in the short term, we see the rebalance wheels continuing to turn as evidenced by sharply cut refiner inputs (which should help tighten product stocks over time) as the IEA expects to see crude stocks draw this quarter. Thus, we are not strongly bearish oil on a longer horizon.
• Away from the oil market the key items this week were US Fed official speeches (Williams + Bullard were dovish, Dudley was hawkish) and of course the release of the July FOMC minutes which were ultimately interpreted as dovish leading to drops in US yields and the DXY. The EUR/USD crossed over the 1.1335 mark for the first time since Britain voted to leave the EU. Our view as it pertains to oil remains that the Fed will continue to talk the Dollar down (perhaps via more helicopter money chatter) and in the unlikely event that a runaway USD sends WTI back into the low $40s it could be a great buying opportunity. However, we also doubt that the Dollar will become a significant bullish input for oil as the ECB, BoJ and PBoC also continue to lean towards accommodation.
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Spreads tighten despite bearish supply news
WTI spreads were treated to a large quantity of bearish news this week beginning with massive floods in the USGC which were believed (at first) to disrupt demand at several large facilities including Exxon’s 502k bpd plant in Baton Rouge and Motiva’s 230k bpd operation in Covent. PADD II imports added to the bearish inputs with a mark of 2.66m bpd (+560k bpd over the last three weeks) while the US rig count increased for a seventh straight week and US production increased by more than 150k bpd due to a ‘re benchmarking’ by the EIA which should receive some clarity in September.
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Prompt WTI spreads actually rallied on the week despite the floods, increased rigs, increased output and flood of Canadian crude after new reports on Thursday suggested that the flooding in Louisiana was actually not as disruptive for refiner demand as previously thought. The same item also provided a bounce to WTI-Brent arbs which have been under signicant pressure for months as demand for brent cargoes improved and the US crude system grew increasingly saturated. Late in the week WTI Oct/Dec traded -1.29 for a 30-cent rally off of its August low and by Thursday afternoon the spread actually was within 7 cents of its 50-DMA for the first time since early June. The Z16 WTI-Brent arb jumped to -1.33 on Thursday after moving as far south as -1.60 on Wednesday. Several reports surfaced during the week that trading groups including Vitol and Astra were busily moving barrels from Houston to Europe to take advantage of the recently widening WTI-Brent arb. Bloomberg reported that as many as 10m bbls could get exported out of PADD III in coming weeks to take advantage of the arb’s biggest discount since December.
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Front Brent spreads also moved sharply higher this week due to continued strong demand in the Houston area for imports (PADD III imports +300k bpd w/w) and news that a significant number of VLCCs in floating storage were lifted by Asian refiners. On the supply side Nigeria joined Libya, Iran and Venezuela this week in stating they would not join any output cut effort. Niger Delta Avengers tweeted that they were unwilling to begin talks with the Nigeria’s government and work towards a ceasefire. Bloomberg reported that Saudi Arabia may break their all-time high output (set in July) in August and pump more than 9.8m bpd.Related: Oil Product Demand In This Middle-East Nation Just Hit An All-Time High
Brent Oct/Dec traded to -0.54 on Wednesday for a 76-cent rally since July 11th. In deferred spreads Z16/Z17 moved as high as -3.13 for a $1.45 rally since July 29th. Strength in brent was attributed to the aforementioned lifting of VLCCs from buyers in Houston in Asia and traders were undeterred by the potential for increased output from core OPEC + Russia while the more tenuous exporters downplayed the odds of an accord this September. Expectations for August supply are currently high for Russia, Saudi Arabia and Iran while some fear that Iraq’s output will fall m/m. Significant skepticism remains towards the return of Nigerian and Libyan barrels.
Funds buy Brent and WTI for the first time since May
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Hedge funds were net buyers of NYMEX WTI last week by 16k contracts and net buyers of ICE brent by 31k contracts. This made the period ended August 9th the first week where the speculative crowd was buyers of both Brent and WTI for the first time since May 17th. On the NYMEX WTI side this included an addition to gross shorts of 2k contracts while gross longs expanded by 18k. In ICE Brent gross shorts were cut by 19k contracts and gross shorts added 12k. We aren’t drawing any strong conclusions from this data beyond some expectations of volatility due to position size and will expect the large gross short position to be covered/added to as the market rallies/drops.
In refined products specs were net buyers of RBOB bringing the net short to just over 1k contracts. The net long position held by speculators in Heating Oil was cut from 7k to 2k. In the ETF world the USO saw net inflows of $45m for the week ended August 12th putting the fund on a roll totaling $370m over the last three weeks.
Oil volatility sinks to three month lows
Crude oil option premiums moved significantly lower this week as flat price moved to its highest level in six weeks and realized volatility sank below 35% for the first time since June. As of Wednesday afternoon the NYMEX/CBOE OIV index marked WTI implied volatility at 35.8% for a 2-month low. In futures markets WTI Z16 implied vol dropped to just 36% for a w/w drop of 3 vols. 25 delta puts on WTI Z16 futures implied 41% volatility while 25 delta calls priced at 37%. In keeping with recent bearish theme ‘wingy’ 10 delta calls priced ½ of a vol below 25 delta calls suggesting a serious lack of interest in bullish tail risk. This trend is part of our short term bearish view on the oil market.
DOE stats greenlight the next move higher for oil
• Headline draw of 2.5m bbls of crude was concentrated in the West Coast after its imports dropped by over 4m bbls w/w
• Cushing, PADD II and PADD III added modest draws despite increased imports from Canada and into the USGC
• Refiner inputs were a bullish +268k bpd w/w
• Solid mogas draws in PADD IB, PADD III and a strong draw in PADD III also looked strong
US crude oil inventories fell 2.5m bbls w/w and are now higher y/y by 14%. PADD I stocks fell 737k bbls (+10% y/y,) PADD II stocks fell 92k bbls (+9.7% y/y,) PADD III stocks dropped 218k bbls (+21% y/y) and Cushing stocks drew by 724k bbls to 64.5m bbls. Imports into PADD II increased by 390k bpd and are higher y/y by 4% while PADD III imports increased by 300k bpd and are higher y/y by 17.5%. US crude oil production increased by 152k bpd to 8.6m bpd which was largely due to a ‘re-benchmark’ by the EIA after weekly model data differed with the organization’s Petroleum Supply Monthly. More light should be shed on the state of US output in the EIA’s STEO released September 7th.
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Refiner demand increased by 268k bpd to 16.9m bpd but is still lower y/y by 1.1% over the last four weeks. Total US refiner inputs are higher by 140k bpd y/y or roughly 0.8%. Cracks margins, though stronger this week, remain seasonally poor with the WTI 321 crack, Gasoil/Brent crack and RBOB/Brent cracks trading at $14.50/bbl, $9.50/bbl and $8.50, respectively. PADD I refiner inputs at 1.04m bpd are lower y/y by 13% and we continue to see this as a signal the product stocks will tighten in the coming months.
Gasoline stocks dropped 2.7m bbls w/w lead by a 2.3m bbl draw in PADD II. Overall mogas stocks are +9% y/y, PADD IB stocks are higher y/y by 29% following a 471k bbl draw, PADD II stocks are +4% y/y and PADD III stocks are +4.3% y/y. PADD I imports fell 256k bpd w/w and are lower y/y by 36% over the last month. Gasoline production is still flat y/y despite recent refiner cuts. Implied mogas demand is higher y/y by 2% after a modest w/w decline.
In gasoline markets prompt RBOB traded over $1.46/gl on Thursday for a 20 cpg jump since July 29th. Spread markets, however, continued to trend bearishly with Sep/Oct moving from as high as +10 cpg on August 3rd to just +6 cpg late in the week. Bloomberg forecast just 14 US bound gasoline tankers from Europe this week compared to 18 last week which may continue to help PADD IB tighten.
Distillate data was bearish this week lead by a 1.4m bbl w/w build in PADD IB. Overall stocks added 1.9m bbls and are higher y/y by 3%. PADD II stocks are tighter y/y by 5% following a 417k bbl draw and PADD III stocks are lower by 1% y/y after a 1m bbl build. Distillate production at 4.9m bpd is lower y/y by 2.6% over the last month (but jumped 200k bpd w/w) while imports remain scarce at just 90k bpd. Distillate exports at 1.3m bpd are lower y/y by 2% and demand at 3.5m bpd is lower by 10% y/y over the last month.
Heating oil futures moved sharply higher this week despite the aforementioned bearish data and crossed over the $1.51/gl line for the first time since early July. The prompt contract is higher by more than 25 cpg since its August 2nd low at $1.2466/gl. Prompt spreads were also strong for heating oil with Sep/Oct trading above -1.6 cpg for a 1.1 cpg rally since August 1st.
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Gasoil futures moved to 6-week highs above $441/t on Thursday while prompt spreads weakened slightly. In storage hubs Singapore’s distillate supplies dropped by 1.3m bbls w/w and are higher y/y by 2%. In Amsterdam-Rotterdam-Antwerp supplies fell by 28k mt and are lower y/y by 2%.
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