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.
Inventory Overview and Discussion:
The net change in overall inventories for the week ending April 7, 2017 was a Draw of 8.0 (as seen in Figure 1 below). For comparison, the net change for this week last year was a Build of 2.9 and 2 years ago was a Build of 1.3.
Ok, so let’s take a look at where we are.
From the Utilization Rate, you can see that we are slowly exiting refinery maintenance season. The decrease in Gulf Coast utilization rate can be attributed to a higher increase in Operable Capacity numbers relative to gross inputs, which obviously decreased the utilization rate (see Figure 2 below).
The Operable Capacity is based on the ‘latest reported monthly operable capacity’ to the EIA. Since the prior EIA report week ended on March 31, it would reflect reported capacity levels for March, whereas this weeks’ report would be updated with April levels. The reported Operable Capacity for April most likely includes updated capacity expectations that may not have fully taken place yet, which is why it ‘appears’ that the Utilization Rate went down in this latest report. This could also account for the slight build to Cushing inventories. I would look to see this ‘catch up’ in the next two week, meaning more inputs of oil into the system. Continue to keep an eye on this.
Price Overview and Discussion:
This week we saw roughly a 3.60% average rally across the board in crude oil prices,building on last weeks’ 3.25% increase (see Figure 3 below). In addition, there was a slight narrowing of the Brent/Dubai spread for the balance of 2017.
As noted last week, the Brent/Dubai spread is an indicator of crude oil movements. For example, Middle Eastern and Russian Crudes tend to be priced relative to Dubai, and West African crudes tend to be priced relative to Brent. Since Middle Eastern crudes (Dubai and Oman) are viewed as lower quality (less ‘sweet’) than Brent and WTI, the narrower the Brent/Dubai spread, the more likely Brent, WTI or even West African crudes will be chosen as an option by Asian and other refiners. These market-driven global flows of oil ultimately impact the ‘supply’ available to any individual region. Of course, freight rates are a key factor as those with access and ability to these logistics will ultimately ‘arb’ out any market disparities.
This is worth noting due to the upcoming OPEC meeting in May. As you know, the cuts that OPEC put in place at the beginning of this year translated to tighter sour crude supply in the Middle East. This is because the bulk of the cuts have come from members that produce and export medium and heavy sour oils. This resulted in a collapse of the “Light/Heavy” oil spreads. Futures spreads between Brent and Dubai/Oman were $6.00+ last year and are now well under $2.00. Watch this spread as we near the May meeting for any big moves indicating market sentiment/positioning.
Many refineries blend light and heavy crude oil to achieve the optimal blend for their refinery. In the US this has been achieved by blending heavier Canadian crude with lighter Bakken oils in an aim to create a cheaper barrel than the price of sour crude in the Gulf Coast. This might be a good time to remind everyone that back in 2009/10 the Saudi’s and other Middle Eastern countries dropped WTI as a benchmark and replaced it with US Gulf Coast Sour (“ASCI”). Couple that with the recent OPEC cuts focused more on heavier crude, and it’s a good time to ponder the REAL strategy and how that might play out in light/heavy spreads if the cuts continue.
Spreads to watch:
- Brent/Dubai spread.
- WTI/LLS spread (as an ultimate destination for WTI Cushing barrels is the Gulf Coast)
- Light/Heavy spreads
Moving on to refined product and related markets (Figure 4 below).
The past week, we saw benchmark Distillate prices for the balance of 2017 increase an average of 3.30% while Gasoline (the leader as of late) increased roughly 2.50% for the same time period. Gasoline prices have been enjoying a combination of seasonal strength coupled with refinery outages. Those refining outages are beginning to wind down, so it’s now up to global demand to do the heavy lifting.
There are so many grades of global refined products that the amount of logistical movements of products to/from the best priced markets are too many to cover in one report. Needless to say, there is a lot going on. There are more than 50 unique spreads related to Gasoil alone listed on exchanges.
One item I will point out this week is the Heating Oil/Gasoil (HOGO) spread. Gasoil futures dropped briefly from around $500/MT at the beginning of March to around $450/MT towards the end of the month. However, since then prices have regained the $500/MT level. Strong demand from Latin America and other counties is diverting US distillate away from Europe. Demand was forecasted to recede the first quarter of 2017, however, in the last EIA report that includes US exports through Jan, 2017, there was no sign of that as of yet. Watch for a widening of the HOGO spread to indicate the potential for steady to increased distillate exports. Things could also get interesting if we start to see an increase in Freight rates.
Week Ahead – Expectations and Wild Cards:
As noted above, the key items to watch in the upcoming week are:
- Refinery Utilization rates, gasoline demand and Oil inventories
- Crude spreads (WTI/LLS, Brent/Dubai, Light/Heavy)
- Distillate spreads (HOGO)
We should expect to see support for WTI above $50 unless there is a material shift in one of the above items.
Implied volatility is LOW across the complex. As noted last week, the Open Interest in WTI options is almost twice that of the underlying futures. Add to all of this the amount of OTC structured ‘costless collar’ type of hedges that have been written out there that never hit the exchange numbers. With prices remaining in a narrow range, low volatility and option strikes being written closer and closer to the money, one has to keep looking for the catalyst that will veer us off this long, narrow road.