(aka, if the broader market weren't so bullish, I'd sell oil)
Author: Brynne Kelly (w/Lee Taylor technical levels)
WTI crude oil has been trapped in the same $2.00 price range since the beginning of July. There are several forces at play here, one of which needs to take the lead in order to break us out of this range. They include:
Inventory
Calendar Spreads
Crack Spreads
WTI/Brent Spreads
Macro Correlations
Inventory
While we have seen some decent draw-downs of US crude oil inventory over the last several weeks, PADD 3 levels (US Gulf Coast) are still stubbornly high (pink line below). Levels for the rest of the country (PADD's 1,2,4 & 5) have managed to come back in line relative to historical levels (blue line). It makes sense that with the bulk of US refining capacity located in and around the US Gulf Coast, low refinery utilization rates impacted PADD 3 inventories the most.
Next, we take a look oil inventory levels and the percentage mix of refiner output (total gasoline and distillate supplied by refiners divided by total product supplied). This gives us an understanding of refining output regardless of the level of refining input. Oil inventory levels are relevant in relation to their produced product counterparts.
When the pandemic slow-down first hit in the US, refiners cut gasoline runs (red line, 2nd chart) and increased distillate runs (blue line, chart 1). Both gasoline and distillate are shown as percentages of total product supplied by refiners. This led to an increase in both product inventories (black line, both charts).
As refiners began to increase runs in May, it was weighted towards gasoline production (red line). As refinery runs of crude oil increased, the gasoline output as a percentage of total output increased while distillate supplied leveled-off. Interestingly enough, gasoline inventories were able to post draws as output increased, which indicates an increase in demand. This was not the case with distillate inventories, which continued to increase even as output declined. It appears as though further increases in output will have to be weighted towards gasoline in order to get distillate inventories back in-line (at least until the winter heating season begins).
This scenario has the possibility of becoming problematic and is therefore keeping a lid on oil prices. Updated gasoline demand forecasts do not look optimistic through the end of the year. One interesting forecast model out there predicting gasoline demand was done by a group at Nature Energy. They developed a "machine-learning-based model of pandemic oil demand analysis" or PODA as they call it. Their model contains two major modules: a Mobility Dynamic Index Forecast Module and a Motor Gasoline Demand Estimation Module
Here is their most recent model update:
This is similar to other developing narratives that suggest we will NOT have a "V-shaped" gasoline demand recovery.
Calendar Spreads
After the initial sell-off in oil, 1-month calendar spreads regained their composure and clustered around a similar level. However, the last few weeks they began to come 'unclustered', suggesting all is not well in the short-term.
Zooming out, we see this 'clustering' and 'unclustering' of spreads, which is often times a precursor to volatility. At the very least, spreads are reflecting the let-down of an autumn demand recovery.
The dynamic is shifting towards one of 'demand may not recover fully, but neither will supply". That's fair, but it's rare to see a bull move come from the back of the curve. So, we are stuck with relative strength or weakness in the front of the market and no one is going to sell the back because of the continued decline in 'rig counts'.
3:2:1 WTI Crack Spreads
The 3:2:1 crack spread is meant to be representative of refinery product output vs oil input. Using Nymex WTI, RB and HO as a proxy for the typical refining margin has lost it's relevance as the bulk of refining activity has moved the the US Gulf Coast, however these are the spreads available in benchmark futures and useful on a comparative level. Below are the Nymex WTI vs Nymex RB and HO 3:2:1 crack spreads for month 2 and month 3.
The main theme here is that as oil prices hold the $40 level, refining margins are collapsing.
WTI/Brent "Export" Spread
Now that the US can participate in global oil markets via exports, the best news exporters could receive is a really wide WTI/Brent spread (the greater the spread, the more the margin for exporting a US barrel - transport costs being equal).
The huge dip in the spread at the end of April was met with buyers eager to lock in export margins. Since then, we see WTI at a -$2.00 discount to Brent being a resistance level. Why? Because given the cost of moving oil from Cushing to the USGC and then the cost to transport it to the UK or Asia, margins are getting thin at a -$2.00 WTI/Brent spread. This is another pressure point on WTI prices. WTI needs Brent to rally.
Macro Correlations
These days its hard to ignore the backdrop of strength in the USD and Gold. These two markets have their own narratives that are spilling over to other markets. One narrative is that a weaker USD leads to an increase in commodity prices. Another narrative is that 'buying gold reflects the inflation that will permeate all commodity markets".
Crude oil isn't buying it yet. Taking a look at recent oil price correlation to the USD index, it registers at a negative (0.43%). This isn't the type of negative correlation that gets you too excited.
Another macro theme that is difficult to ignore is the gold rally. Rallies in any commodity that are pinned to something other than supply/demand are due to spill over into other markets. Strength in gold has piqued everyone's interest. Yet, before you get too excited, the oil to gold ratio since 2019 has been negative.
But, these two macro themes are the yin to oil fundamental's yang. Hence why we are stuck in a $2 range.
Inventory
Weekly Changes
The EIA reported a total petroleum inventory DRAW of 5.40_million barrels for the week ending July 31, 2020. Crude oil alone posted a weekly DRAW of 7.40 (excluding SPR).
Year-to-date, total Inventory additions stand at a BUILD of 145.80 million barrels (vs 151.20 last week). No need to make comparisons because YTD builds far exceed anything on record.
Commercial Inventory levels of Crude Oil (ex-SPR) and Refined Products remain elevated compared to prior years, however Cushing comps continue to keep us in the game.
Lee Taylor - Technical Levels
BRENT
Resistance: 45.71 / 46.36 / 48.94
Support: 41.98 / 39.70 / 36.49
Wednesday was the day for our breakout in the Brent market, however, it too failed. October Brent rallied up to 46.23 just shy of the 50% retracement of 46.36 and the top of the gap of 46.68. If the market cannot get above 45.07 and retest the levels I mentioned above, a move back to 41.07 is quite possible. Oct/Nov Brent has been flirting with the -.34 area for two weeks and I still maintain that unless it can settle above it will trade south towards -.60.
WTI
Resistance: 43.05 / 44.38 / 46.37
Support: 39.34 / 37.80 / 36.08
The market had a little bit of excitement in the later part of last week, unfortunately, it did not create the breakout we needed. September WTI did break above 43.05 during Wednesday’s action but could not follow through. I still do not see the fundamental news causing this market to break to the upside. The economy, Covid-19 and the apparent virtual learning to continue at US schools will quell demand at least through Q3. Look at Oct/Nov WTI spread – resistance slightly above at -.30 and projecting a move down to -.52.
RBOB
Resistance: 1.2245 / 1.2581 / 1.2736
Support: 1.1956 / 1.1789 / 1.1274
The gasoline market, in my opinion, continues to lead the complex; however, it too has been able to break open the ceiling covering the energy commodities. Let us look at some of the spreads this evening. Oct/Nov, Nov/Dec and Dec/March have all been trended lower since mid-June. The spreads have trendline resistance at 171, 93 and -377 respectively.
HEATING OIL
Resistance: 1.2465 / 1.2654 / 1.3023
Support: 1.2062 / 1.1817 / 1.1689
Wednesday’s rally in September Heating Oil finally cracked the gap left in the market from mid-March, however, that is all it did. It quickly retreated from its lofty heights and traded down for the balance of the week. I stated this last week and maintain “the heating oil market will not gather any momentum to the upside until it breaks and settles above our resistance level of 1.3023”. Although we could see a sideways market linger for weeks, there is little fundamental support to keep them even at these levels. Sep/Oct heat now has resistance at -202 with a downside objective of -264.