Author: Brynne Kelly (w/Lee Taylor technical levels)
Over the weekend, we got the news that the UK will go into lockdown on November 5, 2020 through December 5, 2020 except for schools and construction. This is on top of the restrictions we saw go into effect for France, Belgium and Germany last week.
Because this news came out over the weekend, it is a new wrinkle for the market to focus on in the coming days in addition to the plethora of other market-changing events, like the US election, that already exist. To provide some levity to the situation, we review the current state of affairs via refiner demand, supply and market spreads.
US Refiner Demand and Producer Supply
The petroleum complex in the US and abroad has attempted to balance itself since being flat-footed earlier this year. In the US, the amount of crude oil being input to refiners made a slight recovery into August, but has since tapered back off due to hurricanes and economics. The gold line in the charts below represents 2020 weekly EIA refiner inputs (left) vs US crude oil production plus net imports (right). Both are sitting at just over 13 million barrels per day. These 2020 levels are so far below historical averages (black lines below) that they almost have to move in lock-step higher, otherwise one side of the equation could be overwhelmed while the other is starved.
The good news is that this combination of lower refinery runs and lower oil production have translated into an overall drawdown of US petroleum inventories to just slightly above their 5-year average. Absent an immediate reduction in refinery runs tomorrow, the cumulative impact of more restrictions in the UK is likely to be seen in product inventories due to reduced end-user demand.
The market would signal this via crack spreads. So what have crack spreads (vs WTI) done so far this year? The charts below show the current state of affairs of WTI crack spreads to gasoline and distillate. Indeed, they moved significantly lower earlier this year. However, only gasoline cracks recovered (gold line below, left) as refiners reduced runs to keep their refined product inventories at bay. Distillate cracks settled close to their yearly lows as of last Friday (gold line below, right).
Keep in mind, that the refinery futures margins above have led to the refinery utilization rate below (gold line, 2020). Refinery utilization has barely moved off of it's lows for the year. Some of this is storm-related due to the impressive amount of named storms that impacted the US Gulf Coast this year. Regardless, as we see from crack spreads above, there's no doubt that refiners have had little economic incentive to increase runs.
So, what signal does the market need to once again re-balance? If crack spreads are sold as a result of an expected decline in product demand, will refiners further reduce runs? Year-to-date we have only managed to increase runs less than 10% off of their lows. Seasonally, this is a time when refiners begin to wrap-up maintenance work ahead of winter and begin to increase runs. So, does the market need to send a signal to discourage coming back on-line? That would require product prices to fall more than crude oil prices and, as we saw above, gasoline cracks are the place where this signal would need to hit since they have recovered more than distillate cracks.
As we brace for potentially spreading restrictions towards year-end, this has now become a game of 'pick when the low-price, low capital spending' will hinder the ability of supply to respond to a recovery.
Looking at WTI calendar strip futures for the next 5 years it is difficult to find a bright spot. Prices are averaging below $40 through the end of calendar 2022 and are still well below the $45 through the end of calendar 2026. Are these the types of 'margins' that producers would be willing to lock in via hedges??
Speaking of margins, there are few to be found. This is an unhealthy market that is unfortunately still in search of pain points. It's also a market that has required refiners to show as much discipline as producers, with refiners being the first-mover to cut. Going forward, which spread market will bear the brunt of further slow-downs?
Market Spreads
WTI/Brent
Exporting WTI to European markets provides an outlet for US crude oil, but only a small uplift in prices lately. This spread could strengthen even further in the front if European Covid restrictions are met with less buying of crude oil by European refiners.
Calendar Spreads
Calendar spreads are hanging on by a thread. As of Friday's close, one-month calendar spreads (gold line, below) are at their lowest levels in the front, but for the crash in April and May. This collapse in time spreads led to a huge build in inventories earlier this year.
12-month calendar spreads have also struggled to move off of their lows. We see this in the Dec-20/Dec-21 spreads for WTI (blue), RB (pink) and HO (black) below.
We may have found our culprit. The year on year gasoline spread (again, pink line above) seems incredibly vulnerable, especially with the UK restrictions announced over the weekend. In fact, given gasoline cracks and gasoline spreads, we think that any selling not targeted towards those would be an over-reaction. Meaning that if gasoline spreads aren't impacted by year-end demand impairments, the market is saying 'refinery runs at this level are not enough to meet gasoline demand'.
There are way too many moving parts that remain from now until year end to hang your hat on one news development like the one we got from the UK this weekend. There is enormous uncertainty out there including:
Winter Weather
Delayed Election Results
2nd wave of lockdowns in the US
Biden vs Trump victory
OPEC decision on supply cuts
Saudi OSP's for Dec
Of these, we think that OPEC rolling their 2020 cuts into 2021 are one of the most impactful decisions out there. Delayed election results could be the biggest risk to an OPEC decision at their November 30 meeting. We suggest staying focused on the spreads that send the right signal to balance this market.
EIA Inventory Statistics
Weekly Changes
The EIA reported a total petroleum inventory DRAW of 1.80_million barrels for the week ending October 23, 2020 (compared to a draw of 3.80 million barrels last week). Commercial Crude oil inventories, however registered a gain for the week of 3.60 million barrels.
YTD Changes
Year-to-date, total inventory additions stand at a BUILD of 57.40 million barrels (vs 59.20 last week).
Inventory Levels
Commercial Inventory levels of Crude Oil (ex-SPR) and Distillate are still above their 5-year averages.
Lee Taylor - Technical Levels
BRENT
Resistance: 38.34 / 39.32 / 40.45
Support: 36.22 / 33.41 / 29.36
The Brent market appears in a more perilous situation than WTI with regards to how it looks technically. Jan Brent could not hold 38.34 late in the week and now is poised to test 36.22 then 34.86 then 31.26.Resistance lays above at 38.34.
WTI
Resistance: 37.07 / 38.28 / 41.90
Support: 34.83 / 32.59 / 29.67
Technically it does not look good for the oil market, but you didn’t need me to inform you of that. New lockdowns overseas demolished any hope in international travel for Q4 2020 and a resurgence in demand for oil consumption worldwide. The first key level I will speak about 36.02 which is the 50% retracement on the monthly chart. We failed to hold that on Friday, settling below since May of 2020. The next support level from a monthly perspective is 29.01. Not everything is gloom and doom as we bounced twice off the 50% retracement in Dec WTI of 34.83 – a break of that projects down to 32.59 with 37.07 being short term resistance.
RBOB
Resistance: .9966 / 1.0267 / 1.0450
Support: .9612 / .9372 / .9258
The same phenomenon is happening in gasoline as the other commodities in the energy complex. Friday’s dismal close allowed the active month continuation chart to settle below 1.0865 and the outlook is bleak. Short term support is .9372 and major support does not appear until .9258 which is the 50% retracement on this move up from Covid-19s low.
HEATING OIL
Resistance: 1.0641 / 1.0988 / 1.0641
Support: .9908 / .9562 / .9174
Dec Heating Oil was able to settle above 1.0641 and now will test 99.08. Look for traders to stay short in front of 1.0641, but if the market does falter more and break the 50% retracement of 99.08, then 91.74 is the next objective to the downside.