In short, we think the market became impatient with a lack of visible inventory draws four months into OPEC cuts and that Chinese macro concerns, a modest (and possibly transient) uptick in Libyan production and an unimpressive EIA report lead to length liquidation, self-reinforced stop losses and momentum chasing from robots smelling blood in the water.
Prior to Thursday’s spread breakdown we viewed the relative strength of prompt WTI and Brent structure while flat price cratered as evidence that the market was over extended to the downside. We’re obviously reassessing this view now that WTI N17/Z17 and Brent N17/Z17 have broken down to their lowest levels since November and taken out every source of technical support on the trip. Using a wider lens though the spread picture doesn’t look entirely disastrous. WTI N17/Z17’s print of -1.40 offering 28 cents contango per month and Brent N17/Z17’s print of -1.20 offering 24 cents contango per month still imply aggressive inventory draws in 2H’17.
Lost in the noise of this week’s carnage was positive news from OPEC + Russia regarding the (priced in at this point) output cut extension and April data which pegged current cartel output at a 22-month low. Morgan Stanley and Energy Aspects both noted this week that OPEC exports have only decreased in the current deal by roughly 800k bpd as member nations emptied floating storage and this number should increase in 2H’17 as floating storage declines (more on that later.)
We have a positive view of flat price at these levels (this won’t surprise loyal readers) just as we have since $50 but this market is obviously ‘confusing’ us. Given the extremely steep nature of the current selloff, however, we might wait to see some evidence of technical consolidation before getting long. We’re also keeping a close eye on managed money gross shorts in ICE Brent which have a pesky habit of spiking near 100k at market bottoms when bearish enthusiasm is high.
Tanker data shows (very, very slowly) tightening market
Global freight data continued to point towards a slowly tightening market this week with declining floating crude and refined product stocks and falling freight rates. Bloomberg estimates that floating crude inventories have declined from 206m bbls to 160m bbls over the last seven weeks while refined product stocks have drawn from 79m bbls to 72m bbls over the last month. In freight rates the Middle East > Japan benchmark printed 60 on Thursday which is lower by 37 pts since January but still 15% above its 5yr average.
Diff markets continue to show improvement
DFL Brent and Midland-WTI both hinted at physical market congestion in recent months and highlighted bearish trends which eventually doomed flat price this week. Both differentials have performed well recently and we think this indicates at least modest improvement in fundamentals in the Atlantic and Midland areas. DFL Brent has jumped from a low print of -1.23 on April 18th to to -79 cents on Thursday. Back in the US, Midland-WTI strengthened from -1.75 on April 17th to trade -65 on Friday suggesting tighter prospects for west Texas barrels where the rapid production comeback has overwhelmed takeaway capacity.
US production data continued its bearish trends this week and remained the focus of a market which is increasingly impatient in its search for signs of inventory normalization. The US rig count climbed to 697 (its highest mark in two years) after increasing in 41 of the last 44 weeks. US crude output notched another weekly gain increasing to 9.3m bpd and has increased by 865k bbls since July. US crude has recovered all but 317k bpd from its peak of 9.6m bpd in June of 2015 which occurred when the rig count stood near 630.
Option markets get pricey, but with an interesting twist
Crude oil option values unsurprisingly rallied this week as flat price plummeted and realized volatility moved higher. By Thursday afternoon WTI M17 50 delta options implied 31% volatility for a 5.5-vol rally over the last two weeks. The most noteworthy trend in options to us, however, was that upside risk actually rallied relative to downside risk with 25d puts trading at a 1.2 vol premium to 25 delta calls declining from a 2-vol premium for most of the last month. In our judgment this is a bullish sentiment indicator in suggesting that traders were not tripping over themselves to buy puts and chase momentum lower.
USO buying kicks in as fast money heads for the exit
COT data for the week ended April 25th showed aggressive liquidation of length from managed money. Net length between NYMEX WTI and ICE Brent fell by 137k contracts w/w (-18%) and are lower by 33% since mid February when combined net length reached an all-time high of 921k contracts. The net sell efforts came with the help of a 35k contract increase in gross shorts between the two contracts after bearish positions were trimmed for three consecutive weeks.
Refined product speculations showed a similarly bearish trend with funds cutting net length in RBOB and Heating Oil both by about 1/3 on the week. Weekly USO flows are showing a drastically different attitude towards the recent dip, however, with a net buy effort of $199 million dollars over the same period. It’s worth noting that large USO buying preceded crude oil rallies in November and March and sold the recent rally opposite oil’s recent peak in mid April.
Modest crude draws won’t cut the bullish mustard
• Wednesday’s US stat report showed a small overall crude oil draw, disappointing product inventory data and a continued lag in US gasoline demand.
• The takeaway for us is continues to be that a bullish move for oil will require unanimously strong data down the balance sheet in crude oil, gasoline and distillates. This report obviously fell short.
US crude inventories failed to meet expectations of a +2.5m draw this week with a decline of 930k bbls. Overall inventories are +3% y/y with PADD I stocks -12%, PADD II stocks +3.5% y/y and PADD III stocks +4.7% y/y. Cushing inventories fell 728k bbls w/w to a 2-month low of 66.7m bbls. Trading flows continue to provide limited relief for an oversupplied US crude market with exports falling back to 538k bpd while imports printed 8.3m bpd and are higher y/y by 5% over the last month.
US refiner inputs had a modest w/w decline to 17.2m bpd and are still at a substantial y/y increase of 6.6% over the last four weeks. By region, PADD I demand is -8% y/y while PADD II inputs are +16.5% y/y and PADD III inputs are +4.4% y/y. Refinery utilization is currently running 93.3% which is higher y/y by 3.7%. Increased demand continued to weaken margins this week with the WTI 321 crack trading $15.70/bbl while RBOB/Brent traded $14/bbl and gasoil/brent traded $9/bbl. In the Houston area the LLS 321 crack traded $9.50/bbl.
Gasoline data was disappointing against expectations beginning with a seasonally abnormal build of 191k bbls w/w. Overall inventories are flat y/y but PADD IB inventories in the mid-Atlantic fell by 100k bbls and are lower by 3.5%. PADD II stocks added 716k bbls (+3.7% y/y) while PADD III stocks added 867k bbls to a y/y deficit of 1.4%. On the demand side US gasoline exports printed 732k bpd and are +77% y/y while domestic demand at 9.2m bpd is -3.6% y/y.
Distillate data was also underwhelming beginning with an overall inventory draw of 562k bbls. By region, PADD IB stocks added 476k bbls (+2.9% y/y,) PADD II stocks added 1.2m bbls (+1.7% y/y) and PADD III stocks fell by 1.2m bbls (-9.5% y/y.) Overall inventories at 150m bbls are lower y/y by 4.2%. Refined product exports were flat w/w near 1m bpd (+9% y/y) and domestic demand was strong at 4.3m bpd and is higher y/y by 8% over the last month.
The United States Oil Fund LP ETF (NYSE:USO) closed at $9.66 on Friday, up $0.20 (+2.11%). Year-to-date, USO has declined -17.58%, versus a 7.23% rise in the benchmark S&P 500 index during the same period.
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