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.
- 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):
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.
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.
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.
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.
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.
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!