Author: Brynne Kelly (w/Lee Taylor technical levels)
With US election results projecting Biden as the winner, oil markets can now begin to decipher its impact on both short and long term prices. There is no shortage of discussions regarding how a Biden presidency would transform the U.S. energy landscape. But, this objective will take a while to realize before impacting the shape of the longer-term structure. For now the market is still deep in the throes of 2020 demand destruction due to covid-19.
It's no doubt that a Biden presidency is colliding with a significant decline in future capital spending on oil production. Prior to the election, the market had been eagerly trying to figure out the supply/demand imbalance in light of new lock-downs, the impact of reduced capital spending on production going forward and the status of the OPEC+ production cuts. Enter an administration that appears to support a transition away from fossil fuel usage. This puts oil prices in a tough spot. We are entering an environment more likely to seize rapidly on opportunities provided by an oil price increase to justify further proliferation of renewable alternatives.. Stricter carbon limits could be on the horizon and will serve as an additional tax on oil and gas producers and an additional benefit to those generating carbon credits. This will narrow the spread between end user costs of fossil fuels and end user costs of alternatives. However, policy changes take time, leaving plenty of opportunity for the current supply/demand dynamics to play themselves out on fundamentals. It will then be the future term structure that is left to deal with the push/pull of prices vs regulation going forward.
The US refining industry is currently running at only 75% of operable capacity and refining cracks are close to historical lows. The refining community is currently telling us that at current margins and demand levels, they would prefer to balance any weekly shortages via inventory rather than via increased production. Therefore, the return to normal capacity usage should be led by the most efficient resources first. This has and will lead to a shuffling of assets as producers and refiners seek to regrade assets through efficiency gains or through locational favor.
Absent concrete forward guidance until the change in administration next year, we find ourselves again at peak unknown-unknowns. This leaves the market wide open for speculative narratives to govern term markets. To get our bearings going in to this week, we look at the major themes in place last week, some key charts that define the current state of markets and the major themes that can't be ignored going forward.
Last Week in Review - Major Themes
Election Uncertainty
2nd wave of UK/Europe Lockdowns
OPEC Production cuts for 2021 (3 members of OPEC and Russia are in favor of an extension of the current oil production cuts agreed by OPEC+ in April this year)
Inventory levels fall to within 5-year range
Refinery closures - Shell announced the shut-down of it's Convent, LA refinery
China’s Crude Oil Imports Sink In October
Key Charts to Watch
Refinery Utilization/Production
As noted earlier, the refining complex has struggled to move above a 75% utilization rate (yellow line, left chart below). This has put a governor on US crude oil production yellow line, (right chart below)
There is a seasonal trend in play from now until year-end where refinery utilization rates increase as units exit fall maintenance. Over the last 5 years, the amount of crude oil input to US refiners has increased by 1.1 million barrels per day from October through December (blue bar below). Even with the significantly reduced demand for crude oil by refiners in 2020 (yellow bars below), demand still held on to its seasonal shape over the summer. The balance is so delicate between production and utilization at these reduced levels. If one were to move faster than the other, we could see increased volatility in the front of the market in response.
Crack Spreads
Increasing refinery utilization is highly dependent on crack spreads. These are currently sitting on their lows on a comparative basis over the last 5 years (yellow lines below).
The question becomes whether a move higher in oil prices can be matched with an equal or greater move higher in refined product prices. If not, what is the path forward for a recovery in refinery utilization??
We have reached unusual territory where one-year crack spreads vs WTI have converged. This doesn't leave much room for oil prices to recover without an equal recovery in refined product prices. Absent that, refiners will continue to withhold capacity.
Term Structure
The shape of the WTI term structure has varied widely this year, moving from decidedly backward to decidedly contango (top line vs bottom line below) before recovering. As of last Friday's close (yellow line below) we notice that the back of the curve in 2026 closed at yearly lows. What are we to make of a curve structure that is struggling to remain above the $40 level for the next 6 years?
Export Arbs
It's tough to find more clear evidence of how thin margins are in the oil complex than the WTI/Brent spread. This spread has rallied all year, meaning that the 'arb' between WTI and Brent crude oil has gotten smaller. This points to how competitive the global market has become in a lower demand environment. This theme was in place long before US presidential elections and is one that still needs to be deciphered going forward.
Calendar Spreads
Three, six and twelve-month calendar spreads have been the battle ground where the bulls and bears have fought for dominance since their rapid decline in April when flat price came unglued. We highlight this via the Jan-21/Apr-21, June-21/Dec-21 and Dec-21/Dec-22 calendar spread charts for both WTI (left) and Brent (right) below.
All three spreads have strengthened off their lows from earlier in the year. The three and six month spreads in both markets have converged, however there is more relative weakness in the Brent 12-month Dec-21/Dec-22 spread (yellow lines above) than in WTI. This is frustrating for the oil bulls as Brent is often seen as a leading indicator of global demand. There is no doubt that a 2nd round of lockdowns in European countries is weighing down Brent markets, but one should be mindful of the disparity in 12-month spreads if what is happening in Europe portends what is to come in the US,
With December being the front contract on the board, the 12-month Dec-20/Dec-21 spread is getting volatile. Interesting, however that the WTI spread weakened last week (black line) while product spreads rallied. (pink and blue lines below).
This resulted in a slight rally in RB and HO crack spreads vs WTI in the front of the curve. This is something to keep in mind as a trend that was already in place prior to US election market gyrations.
Influencing Themes Going Forward
While the market sorts out the macro impact of the US presidential election on oil markets, it's important to remember the themes that were unfolding prior to that.
India
India is a growing consumer of oil and currently imports about 85% of its oil needs. While a Biden administration may be seen as 'friendly' with India, this may impact US LNG exports more than US Oil exports. In a bid to curb the country’s rising dependence on imported crude, the oil ministry has been trying to push for higher adoption of natural gas and alternative fuels to displace the demand of crude oil. There is a push to quickly to meet Prime Minister Narendra Modi's target of cutting import dependence by 10 per cent by 2022. We provide this gentle reminder as there has been jawboning out of India regarding the US election results. Specifically:
"Biden's victory "spectacular," Modi said in a Nov. 8 tweet: "As the VP, your contribution to strengthening Indo-US relations was critical and invaluable. I look forward to working closely together once again to take India-US relations to greater heights."
The path to less reliance on imports of crude oil for India lies in displacing oil and oil related product consumption with LNG, not with more US crude oil.
Imports vs Exports
As noted in the WTI/Brent spread charts above, the US export 'arb' has narrowed significantly this year. Countries that import oil have a lot to choose from. However, the WTI/Brent 'arb' would need to widen-out in order for the US to continue to grow it's export volumes. With Covid-19 hampering demand across the globe, it may become more interesting for international producers to focus on owning assets in or near geographic demand centers rather than rely on export margins to solve the equation. In theory, the most efficient supply should return to market first. Production growth can no longer be assumed absent efficiency. This chess game has the potential to decouple the front of the market from the back. Volatility in the front of the market could go unanswered in the back of the curve as the market is hesitant to provide long-term direction.
If the US oil supply gets less reliable to importers....based on lack of capital spending...
Supply/Demand Imbalance
Prior to the US election, the market was trying to nail down when or if there will be a pain point due to reduced capital spending on production. In addition to weekly rig counts, frac spreads are used as a guide to indicate the amount of activity being dedicated to completing wells. According to marcellusdrilling.com, "while the drilling rig count is an important signal for the future of oil (and gas) production, drilling a hole in the ground is only half of the process (and only one-third of the cost). After the hole is drilled comes “completions”–fracking and other work to get the hole producing and connected to a pipeline. Fracking is done by a collection of equipment–things like high-pressure pumps. It’s known in the industry as a “frac spread” (or a “frac fleet”). Counting the number of frac spreads is a better indicator of how much oil will come online than counting active rigs."
While the number of frac spreads (purple line below) have moved off their lows from earlier this year, it's certainly nothing to write home about. Total US oil production has been choppy (green line below) and unable to sustain any significant recovery.
USD
There is much written about the inverse correlation between the USD and crude oil prices. As noted earlier, when there is uncertainty and a lack of a clear path forward markets tend to cling to macro forces. One of those macro forces taking center stage is the decline in the USD. Historically, a trend lower in the USD has led to a 'risk on' appetite in equities and commodities. We see this relationship in the chart below over the last several years.
Indeed, there is a macro inverse relationship over time, but we think that the USD would have to breach 2018 levels before materially becoming the wind beneath oil prices. Until then, inverse moves in oil prices in response to movements in the USD will be choppy and short-lived.
While there is uncertainty in how / when the new administration will impact the energy complex, it's important to not lose sight of existing trends. These trends have been fragile in their development and are no doubt vulnerable to a macro shift in policy. However, policy changes take time and fundamental narratives will continue to reign until there is more clarity.
EIA Inventory Statistics
Weekly Changes
The EIA reported a total petroleum inventory DRAW of 8.10_million barrels for the week ending October 30, 2020 (compared to a draw of 1.80 million barrels last week).
YTD Changes
Year-to-date, total inventory additions stand at a BUILD of 49.30 million barrels (vs 57.40 last week).
Inventory Levels
Commercial Inventory levels of Crude Oil (ex-SPR) and Distillate are either slightly above their 5-year averages or slightly within their 5-year average.
Lee Taylor - Technical Levels
BRENT
Resistance: 40.45 / 41.88 / 43.05
Support: 38.34 / 36.22 / 34.86
The Brent market rebounded just as WTI did last week. Looking at the weekly charts, 34.86 represents support followed by 31.26. The important resistance levels to look at is just under 42.00 (41.88). Look for the market to trade between 38.34 and 41.88 unless there is some major fundamental news this week. Upside objective in Jan/Feb Brent is -.30.
WTI
Resistance: 38.74 / 39.93 / 41.90
Support: 37.07 / 36.08 / 34.83
The crude oil market rebounded well after last Sunday night’s sell-off. There was plenty of news this past week which played into the price movement. One technical point to focus on was the fact that on Monday December WTI was able to settle back above 37.07 and used that number as support for the balance of the week. There is plenty of support in the market from our previously-mentioned 37.07 level down to 36.08. Crude Oil spreads also rallied throughout the week, only to retrace a bit on Friday. Look for Dec/Jan to have a difficult time breaking above -.30 on a short-term basis.
RBOB
Resistance: 1.1158 / 1.1374 / 1.1473
Support: 1.0604 / 1.0362 / .9961
1.0881 should be the level that we keep in our mind all week with regards to gasoline – it is the 50% retracement off of last Monday’s low. If December gasoline cannot hold 1.0881, look for spreads to retreat a bit like Dec/March, pulling back to -180. Dec/March RBOB just made a recent high on Friday at -103, a settle above -106 projects up to flat then +55.
HEATING OIL
Resistance: 1.1635 / 1.1782 / 1.2142
Support: 1.1420 / 1.1196 / 1.0973
The story of this week will be if the oil market can maintain the rally off its lows from last Sunday night. The heating oil market should be fine and even if it cannot hold the first support level it will have a difficult time breaking under 1.1196. Dec/Jan should continue to trade between -103 to -72 for most of this week.
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