Is there more to OPEC’s strategy than meets the eye?

by Brynne Kelly

[email protected]

May 18, 2017


Is there more to OPEC’s strategy than meets the eye?

When oil prices soared to $100 plus for a sustained period of time, the ‘capability to produce more’ was born.  The US and other producing nations rushed to unlock technologies that had previously been uneconomic and unnecessary.  Was OPEC watching as that last barrel came on-line and broke the camel’s back or did they severely underestimate the innovation that soaring prices would create?

Sustained higher prices fueled innovation in drilling and extraction and also fed the renewable enthusiasts.  The subsequent fall in prices then led to cost cutting and production efficiency.  At $100 a barrel for oil, it was easier for ‘green’ technologies to get their foot in the door using the economic argument.  We then saw stricter fuel efficiency mandates, government subsidies that encouraged ‘switching’ to renewable sources, and the idea of energy ‘choice’ became more mainstream as electric vehicles and solar panels gained momentum.  This left the world with a slump in organic demand for oil and oil products and consumers with the idea that they can ‘choose’ the type of energy they buy.

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When OPEC finally announced production caps at the end of 2016 the substance was interesting from two perspectives.  One is the bulk of them came from members exporting medium and heavy sour oils, another is the impact the light/heavy spreads are having on the economics for global oil movements.

It has now been telegraphed that OPEC may agree to extend the production caps at their upcoming meeting.  Is there something more to this strategy than meets the eye?  As they face growing competition from other producers like the US, OPEC’s motives may extend beyond just general price support.  Meaning, is their strategy intended to support their ‘brand’ of crude over lighter brands and will that lead to more disparity in light/heavy crude spreads.  How will that impact the growth of US exports?

Let’s look at the price impact of reducing the supply of heavier crude grades from the market so far this year:

ASCI Sour Crude, Canadian Heavy

The value of WTI relative to both USGC Sour and Canadian heavy crude fell.  We know that refineries are specifically configured to process the most economic grades of oil available to them.  This is how they work their strategic advantage.  For example, since the US has historically been a net importer of oil, and heavier grades were the cheaper option to import (from Canada, Mexico and the Middle East), many US refineries were configured accordingly over time. In addition, many of Asia’s new refineries are designed to run on medium and heavy crude that has a higher diesel yield.  With their proximity to the Middle East’s supply of heavier production, this made sense.

In the mean-time, new supplies of US shale production are now ready to hit the global market and it’s primarily light, sweet oil.  The US has invested heavily in and around the Gulf Coast to accommodate exporting their new-found supplies as slowing local demand has spurred a search for new markets.  They are now juggling the task of importing the slate of crude grades that meet local refiner specifications along with exporting excess production of those that don’t.

Of the 3 main benchmark oil futures contracts, WTI, Brent and Oman/Dubai, WTI is the ‘lightest’ and Oman/Dubai is the ‘heaviest’.  With OPEC cutting the supply of heavier grades from the market at the same time lighter supply is growing, spreads between benchmark oils continue to reflect that.

The loss of premium of WTI over the OPEC basket price can also be seen in the spot market.


The question is, how much of this can be attributed to the heavy US refining maintenance season this past spring and how much is attributed to tighter supply of heavier grades?

Even with the rally in outright prices this week, WTI was the weakest performer.

Brent crude lost value relative to the heavier Dubai grade, but gained slightly relative to the even lighter US grades.  This has been the general trend all year, but has gained some momentum as talks of continued output cuts emerged.

However, it’s interesting to note that while December 17 vs 18 spread in both WTI and Brent futures dipped into contango territory briefly when the market sold off early this month, Dubai(Oman) didn’t follow suit.

I take this as a sign that the market realized any tightness created by summer seasonality and production cuts will be short lived.  Said another way, inventory levels are still high and the market doesn’t want to create incentives to store more via contango.  At this point, any rally in outright prices needs to be led by the front of the market in order to disrupt the mind-set that historically high inventory levels equals low prices.

It’s worth noting that crack spreads moved higher this past week in tandem with the oil price rally.

Spot gasoline prices have been lackluster so far this month with the exception of the West Coast which is still experiencing refinery outages and are now well above levels seen this time last year.

Turning to EIA Inventories.  Was a small draw of (0.4) in gasoline inventories this week all it took to change sentiment?

With this week’s crude draw of (2.5), the total change in inventory over the past 6 weeks have been impressive relative to the same 6 weeks in prior years:

Gasoline inventories, however, remain a net injection over the 6 week period.  The picture is quite different from this period last year which points to the difference in the refinery maintenance season year over year.  Now that the Gulf Coast refiners are mostly back on-line (as seen in the refinery utilization rate for PADD 5 in the inventory table above), it remains to be seen if summer gasoline demand (plus exports) will outpace production and draw down inventory.

We have watched the increase of oil storage capacity over the past year as the market caught up to growing production and the desire to have export facilities.  Growth in both storage capacity and the inventory to fill it has weighed on the market heavily.  Take a look at a comparison of WTI prices to ending inventory levels over time:

Does adding more capacity to store automatically mean lower prices once it has been ‘filled up’?  The success of our ability to absorb this storage capacity as the ‘new norm’ seems to hinge on the viability of the export market.  As noted above, for now, OPEC cuts have been more helpful to heavier crude markets.  But, might it be reasonable to think that with this expanded capacity comes a higher base level of oil in storage to support an export system?  If so, prices have room to move higher.

For now, the US is brimming with light, sweet crude oil in a global market dealing with OPEC’s attempts to tighten heavy and sour oil supplies, but it’s a long way from where we were this time last year before any cuts and still just getting our feet wet with crude exports.

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Global Oil Spreads Are the Key to Balancing US Oil Inventories

Is a Rotation Out of Oil Into Equities Underway?

Putting Gasoline Inventory Build Into Perspective

Global Oil Spreads are the Key to Balancing US Oil Inventories

by Brynne Kelly

May 12, 2017

Just like the delicate balance between a strong versus weak currency, oil prices between OECD and non-OECD regions need to strike a balance.  US Exports to Non-OECD regions will be the key to balancing growing US production versus slowing US demand growth:

Since the last OPEC cuts were announced, WTI crude oil has gone from trading at a $2.50 premium to the OPEC basket price to discounts of up to $2.00 (see Figure 1).  With the export ban lifted, the US is now positioned to take advantage of a weak relative ‘currency’ (oil price) by moving US production to more expensive global markets.


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Figure 1.  Prices before vs after OPEC cuts

This is certainly the dilemma that OPEC faces going forward, starting with the upcoming May 25 meeting.  OPEC used to be the Gold Standard to which world oil prices were pegged.  As in 1971 when the world moved off the gold standard, so too is the world now slowly moving off the ‘OPEC-Standard’.  The shifting of the supply/demand picture between regions is forcing producing nations into ‘currency’ (oil price) wars.  At this point in the game, OPEC production cuts only strengthen their relative ‘currency’ (oil) in the short-term making ‘currencies’ (oil) from other countries more attractive to buyers.  The path to outright price inflation is becoming less clear.

The move in spread relationships among the various futures curves this past week (Figure 2 below) highlights the uncertainty in relative prices as the market awaits the upcoming OPEC meeting.   Will production in the US continue to find a home in growing global markets or will production from other countries be more price-competitive?  Notice that the back-end of the WTI and Brent curves gained relative strength to their Oman counterpart in the Middle-East and are actually up week over week.

Figure 2.  12 month futures price relationships

Is this an anomaly or a lack of confidence that US exports are viable at these levels?  For now, the price ‘wars’ will continue to search for a balance.


Weekly EIA Inventory figures posted a net Draw of 7.5 for the week ending May 5, 2017 (Figure 3).  The market finally got its much-anticipated draw in gasoline inventories of (0.40).

Figure 3.  Weekly EIA Inventory Statistics

EIA Inventory

To provide context, Figure 4 takes a look at inventory changes for this week over the past 3 years.

Figure 4.  Comparison of this week’s inventory change to prior years

With total inventory levels still at the top end of the historical range, it will take a lot more than this one week’s draw to change the overall picture.  If we simply take the average summer inventory draws over the past 3 year, September-end total inventory levels still look historically high:

Figure 4.  Comparison of this week’s inventory change to prior years

2017 end of summer crude oil inventory projection

Bottom-line, inventory statistics still aren’t providing a catalyst to break us out of the $45-$55 range.

What do Futures Curves tell us?

Crude oil futures prices for the balance of 2017 fell just under 1.0% this week and were essentially unchanged in the gasoline and distillates.  While gasoline cracks continued to hold their ground, Ultra Low Sulfur Diesel(ULSD)/Heating oil cracks also found a bit of a bottom.

In-line with things outside of the US gaining relative value, note that it was the non-US ULSD cracks that moved higher relative to their local crude oil market.  This makes sense given relative overall demand growth ‘US versus non-US’.  As WTI is the least expensive of the 3 benchmarks right now, US refiners are the winner in the product markets.

These relationships are helping move oil through the ‘system’.  The question is how much price incentive OPEC is willing to provide to non-OPEC producing nations.

With the next OPEC meeting 2 weeks away, markets appear relatively ‘status quo’ rather than ‘bracing for impact.’

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Is a Rotation Out of Oil Into Equities Underway?

Putting Gasoline Inventory Build Into Perspective

Crude Oil Market Not Willing to Pay for Storage

Is a Rotation Out of Oil Into Equities Underway?

by Brynne Kelly

[email protected]

May 5, 2017

Rotation from Oil to Equities??

As the upside picture for crude prices is called in to question in light of the deteriorating supply/demand picture, ‘capital’ may be moving to markets with greater upside potential. Could that be what we are seeing in the chart divergence above?

Equities aren’t the only market holding relative value this week.   Crude Oil is losing ground everywhere you look.

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WTI versus Natural Gas

While there is no real direct correlation between WTI and Henry Hub, they are both part of the ‘energy complex’ and you can see below that the ‘spread’ is now lower than it was at this time last year.

WTI versus NGL’s

In addition, the NGL components, that are often considered to follow the price of oil, fell a combined 2.33% for the June contract compared to WTI’s 8.26% decline for the same period.

WTI versus Gasoline

Even the front months of the gasoline crack held steady amidst the continued slide in petroleum prices during the May 4 trading session.

So the question is:  Will oil pull the above-mentioned markets lower, are they signaling a bottom or is oil on a path of its own?

This week’s EIA statistics

Weekly Oil Inventories showed a net DRAW of 2.7 for the week ending April 28, 2017; Crude draw overshadowed by a slight BUILD of .2 in Gasoline stocks (see detailed stats in Figure 1)

This week’s gasoline build of .2 brings the 4 week total to a build of 2.1.

How the 1 and 4 week-cumulative inventory changes stack up

Looking at the EIA report (below) of total gasoline supplied alone, nothing stands out.  However, the conclusion of the market is that due to the builds in gasoline the demand-side of the equation is where the problem lies.

Which is exactly what we see in the weekly US Gasoline demand stats (below)

This reminds me of natural gas inventories heading into the winter season. Everyone is full of anticipation waiting for the demand (weather) to show up to use all of the production that has been stored away.  If the weather doesn’t show up, the market moves on and focuses on the next demand season.

If we don’t see the gasoline demand materialize, a similar thing will happen in the oil complex.  The market will move on from “driving” season to the next demand season, which in this case is heating (heating oil) season.

Perhaps they already are.  You can see below that the heating oil cracks sold off more this past week than gasoline cracks did.


Crude Oil Prices and Spreads

There was a mixed bag when it came to the crude oil spreads (arbs) this week.  Both the Brent/WTI and Brent/LLS spreads fell slightly versus last week in the front of the curve, but actually increased over last week in the back of the curve.  That was not the case for the Brent/Dubai spreads in which the entire spread curve shifted lower.


Demand-willing, the spreads still favor US crude oil moving towards Europe and Asia.  The tighter Brent/Dubai spread also increases the competitiveness of North Sea crude against Middle Eastern grades, meaning we should see a widening of the Brent/WTI spread.   Any increase in shipping rates at this point would throw a wrench in all of these movements.

Crude oil prices (Figure 2 below) fell an average of 3.2% since last week’s report with gasoline prices down another 4.6% and distillates down 7.3% (Figure 3 below).  The Dec7/Dec8 spread held on to its slight backwardation in oil with the Jun7/Dec7 spread contango widening by $0.14, not a ringing endorsement for short-term oversupply. Rather, it points to a general expectation of current conditions to persist throughout the rest of the year.














Due to seasonality, the Jun7/Dec7 in gasoline is almost $7.00 backwardated while The same spread in heating oil is $1.20 in contango.

This, unfortunately, will incent refiners towards gasoline production in the short term since it carries the highest premium to crude oil prices in the market.

Comparing this week’s production and inventory levels to the same week in 2016, 2015 and 2014, the percentage change in US oil prices are certainly reacting negatively by varying magnitudes to the percentage that current inventories exceed those in prior years.  Keep an eye on these year over year percentages going forward.


What to look for in the coming week:

  • Entry point into any of the ‘one-off’ spreads (ES/WTI, NG/WTI, NGL/WTI) mentioned above if you believe they will revert to the mean.
  • RB and HO cracks.  Front month gas cracks are at 4 year lows  for this time of year, but if demand doesn’t materialize relative to supply, refining margins will have to get ‘punitive’.

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Putting Gasoline Inventory Build Into Perspective

Crude Oil Market Not Willing to Pay for Storage

Putting Gasoline Inventory Build into Perspective

by Brynne Kelly

April 28, 2017

Weekly Oil Inventories showed a net BUILD of 1.7 for the week ending April 21, 2017; Crude draw overshadowed by a BUILD of 5.9 in Gasoline and Distillate stocks combined:

This week’s gasoline build of 3.3 flips the 3 week total to a net build of 1.9 as seen below making for a dismal comparison to the same 3 weeks in 2015 and 2016 (see detailed stats in Figure 1).

The Fundamentals:

While the 3 week changes are more reflective of the end of refining maintenance season when crude oil inventories begin to draw down and product inventories increase, the continued build of gasoline is the bottleneck and a point of contention for a balanced market.  Until there is evidence of increased demand drawing down this inventory, gasoline cracks will be under pressure.  The refining incentive to produce gasoline has been high and will continue to favor gasoline unless near-term spreads retreat.

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The term structure of RBOB gasoline crack futures week over week reflects the pressure on near-term margins:

RBOB, Curve Shift, RBOB Crack Spread, Refining Margin

The shape of the curve also represents the seasonality of gasoline demand and refinery outages.  If stocks continue to build at current rates, we should expect the front month cracks to shift lower until production responds.  Watch the June7/June8 RBOB crack spread which moved from $0.50 backwardation last week to almost $0.70 contango this week.

Compare the EIA chart below to the shape of RBOB futures curve. Historically, gasoline inventories tend to level off or decline at a slower pace during the summer until building again towards the end of the year.  To date, we are sitting at the top of historical 5 year ranges.

EIA historical gasoline inventories, EIA inventory projections, Distillate Inventory

Gasoline build, Distillate Build, Inventory glut

Prices across the Petroleum complex fell another 2.5% week/week in response to Inventory report:

What’s most notable this week is the relative shift in US prices (LLS and WTI) versus European and Mid-East prices (Brent and Oman (see Figure 3 for detailed price curves).

WTI, Brent, OMAN, USGC Sour, LLS, WTI Oman spread, LLS Brent Spread

Bottom-line, incremental demand for US crude will come from Asia and the Middle East.  Like all refiners, they are interested in the most competitively priced grade of crude oil.  There won’t be a massive outpouring of US crude oil from the Gulf Coast unless price spreads support it.  We have seen an expansion of pipeline and export infrastructure into and around the Houston/Corpus Christie area to enable export demand.  Since the majority of USGC refineries are still consumers of medium to heavy sour crude oil, finding a home for US light shale oil is key.  Any relative weakness of US prices can be viewed as a competitive advantage. 

Speaking of competitive advantages, the much-anticipated Dakota Access Pipeline is scheduled to begin operations in May.  This offers an alternative to oil transported by rail out of the Bakken area.  Rail transport costs to the Gulf Coast average between $7.50-$11.00.  Transport rates on the new pipeline are  in the $5.50-$7.50 range depending on service level.  This basically cuts the delivered price of Bakken oil into the USGC by an average of $2.00 and makes it more profitable to move barrels south versus by rail to the East Coast.  Now it’s just up to spreads like LLS/Brent to provide the export economics.

The OPEC cuts at the beginning of this year were focused on sour grades, which have since garnered a premium to lighter, sweeter grades.  This is forcing the hand of refiners around the world (including in the USGC) to enhance their ability to process the cheaper, lighter oil grades.  These type of changes take time, but speak volumes regarding economics.  If light, sweet shale is here to stay and OPEC cuts have made heavier crude grades more expensive, the long-term impact could be that refiners will shift their operational capability in favor of lighter oil.  We know that Japanese and other Asian refineries have been testing their capability to refine US shale oil in anticipation of a cheaper supply source.

With all the talk of growing US crude oil production, it’s easy to lose sight of OPEC cuts versus US growth.  As of the last production figures, OPEC production cuts have been greater than US production increases.

OPEC cuts, US production

This is why the May OPEC meeting is important.  Will they continue to limit production of the heavier crude grades that current refining capacity craves at the expense of impacting a long-term shift in refining preference for cheaper, light shale oil?

Crude oil futures, weekly price change, LLS WTI spread, USGC Sour Crude oil, Brent Dubai spread, Dubai futures

Refined product prices also took a hit this week.

The build in gasoline inventories led to a decline of 7.5% this week of gasoline cracks while the blended gasoline and heating oil 3:2:1 crack spread fell a bit less at 6.7% (See Figure 4).  Any relative increase in distillate demand could help support overall refining margins and take the pressure off of gasoline production.

Another component of the summer gasoline season is ethanol blending.  So far, the selloff in crude oil and gasoline prices haven’t translated to ethanol prices:

Ethanol futures, ethanol blending, rbob futures

With 2017 blending mandates already in place, the ratio of ethanol to gasoline prices is a dynamic to keep an eye on.  This past week, we saw the ratio move above 1.0 in parts of the term strip meaning ethanol prices are higher than gasoline prices.

ethanol vs rbob


Week Ahead – Expectations and Wild Cards:

As noted above, the key items to watch in the upcoming week are:

  • US term structure vs Europe and Asia and the LLS/Brent spread
  • Gasoline Demand and the crack spread term structure
  • Distillate margins
  • Discussions surrounding the May OPEC meeting.

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Weekly Gasoline Build – Anomaly or Start of Trend?

It’s easy to get caught up in the daily grind of price action and market sentiment.  Sometimes it’s good to take a step back and look at the week in review to bolster your conviction for the week ahead.

Key Points:

  • Weekly gasoline build – an anomaly or a sign of a trend?
  • Increase in overall inventories since the export ban was lifted is tracking with the growth of US working storage capacity keeping contango at bay.
  • Spreads between crude grades globally that have been supportive of US exports are narrowing (keep an eye on the WTI/Dubai spread)
  • Front-month gasoline cracks held relatively stable given the bearish interpretation of this week’s gas build.

Weekly Oil Inventories post a net DRAW of 1.5 for the week ending April 14, 2017; Gasoline build the outlier (Figure 1):

Refinery Utilization Comparison by Year

However, given the move lower in prices, let’s take a closer look at the past Two week stock changes.  Below you can see that total inventories have declined by 9.5 (thousand bbls/day) this year, yet we saw builds in inventories those same 2 weeks in 2016 and 2015.

EIA 2 week stock changes tell a different story

The sticking point for the market is clearly the build this week in gasoline.  Looking at absolute gasoline inventory levels below, I don’t believe this weeks’ data point ALONE is enough to solidify a trend of oversupply this early in the summer season.

Another way to keep storage levels in perspective is to look at the growth in storage capacity.

Figure 2 below highlights that the growth in total inventory levels is tracking slightly below the growth in working storage capacity (from the most recent EIA data through September, 2016).  I understand that this is not a 1:1 comparison, however, it’s still relevant to the narrative.   Growing capacity tends to reduce overall price volatility (as long as that capacity is used), but for short-term disruptions in the system.  Risks to going long here hinge on whether a real trend is developing in gasoline withdrawals and the upcoming OPEC meeting.

Oil Working Storage Capacity Increases

The lifting of the export ban at the end of 2015 brought with it a tank storage boom.  The market seized the opportunity to build pipeline, storage and dock logistics to capture favorable arbitrage economics and keep the export flow going.  The most significant build-out of crude oil offloading and storage facilities has been along the Gulf Coast.  Then in January, 2017 OPEC cut production of mostly heavy crude oil which opened up the arbitrage opportunities for exports.  Going forward, crude oil production levels, the relative price of crude oil in North America to other markets, the market price structure and the cost of transportation will determine whether exports will continue to grow and if even more infrastructure is needed.

A key consideration in the build-out was the need to address the mismatch between the light sweet quality of most of the new crude now being delivered to the Gulf Coast from areas like the Bakken, and the heavier crudes that many refineries are configured to process.  The Gulf Coast system has continued to add capacity in anticipation of increased throughput.  See discussion in the next section regarding WTI’s discount to Dubai and other Middle Eastern heavier crudes which makes WTI more attractive for Asia.

Futures prices across the Petroleum complex fall roughly 4.75% week/ week in response to Inventory report:

Figure 3 below details the price declines of the key benchmark crude oils and spreads. Overall, calendar spreads moved in a bearish direction along with the outright price declines.

1 Week Change in Crude Oil Prices, Calendar Spreads, Location Spreads and Quality Spreads

That being said, the June/Dec contango for US crude grades widened by less than $0.20 while the same spread for benchmark European and Asian crudes widened by more than $0.40.  Spreads across crude grades were largely unchanged with a slight narrowing of the WTI/Brent and LLS/Brent spreads by a marginal $0.17 for the balance of the year.  The narrower these spreads, the more economically enticing it is for US refiners to import foreign grades.  In general, crude spreads have been tight enough this year that logistical ‘arbs’ (moving oil from one market to another) require a lot of creativity.  The WTI/Dubai spread is the one to watch.  When WTI trades at a discount to Dubai, the US export ‘arb’ to Asia is open.  WTI’s discount to Dubai narrowed by roughly $0.15 yesterday for the balance of 2017 to around ($0.80).  Looking out into 2018 however, the WTI discount to Dubai narrows to around ($0.25).

Except for the initial market adjustments to the Light/Heavy crude spreads due to OPEC cuts there aren’t many overall price differences to pull crude significantly from one market to another (absent specific refinery requirements).  Will this be the impetus that slowly backs up crude inventories in specific regional markets?  The US Net Import number will be key to watch.

Speaking of Net Imports, Figure 4 below shows a high-level comparison of total supply, net imports and futures prices for the last 3 years.  Clearly, the reduction in Net Imports has been a key balancing factor.

Net Imports and Production changes compared to Price changes

Product prices decline slightly less crude, dropping just over 4% for the week (Figure 5 below).

**One thing to keep in mind when looking at settlement prices is the fact that different market closing times across the globe lead to a mismatch of settlement prices.  This is evident in Gasoil prices in Figure 5.  European oil markets settle at 11:30 EST.  Meaning large afternoon price swings in the US aren’t reflected well in spread settlements.

Petroleum and related product futures prices in $/Bbl

While the product markets seemed to key off of an unexpected build in gasoline inventories, the decline in front month gasoline cracks was relatively muted as was the front month (June/Dec) backwardation.  In general, this would favor pulling barrels OUT of storage, not building.   Typically, if the Market is fearful of excess inventory levels such as gasoline, there would be big moves lower in cracks to discourage production.  Instead, the entire complex moved lower in unison without much change in spreads.  We shall see.

Week Ahead – Expectations and Wild Cards:

As noted above, the key items to watch in the upcoming week are:

  • Signs that this week’s gasoline build was a trend or an anomaly. Look for front month gasoline cracks or backwardation to collapse further to indicate a trend vs. anomaly.
  • WTI/Dubai Spread movements that would be problematic for US exports.
  • Increases in storage capacity seem to be accommodating current production and inventory levels without widening the contango in the front of the curve.

There is nothing wrong with pre-positioning based on the expectation that the above conditions will change.  Just make sure you know what you’re looking for!