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Crude Oil: If it Doesn't Bleed, it Doesn't Lead

Author: Brynne Kelly (w/Lee Taylor technical levels)

Crude oil prices were bleeding and leading in April as spot prices briefly dipped into negative territory. Without a new headline, the energy complex is struggling to attract new capital. This week we look at the impact this is having on the term structures of the petroleum complex.

Crude Oil

Front-month WTI crude oil prices ended July slightly higher than where they began the month. It was a fairly uneventful month in month-one futures. The notable event was the overall shift in the 12-month curve structure. We moved from fairly benign contango at the start of July to fairly steep contango by the end of July.

There was a lot of recovery work done on the term structure from the end of May through the end of June. We see that below in the Dec-20/Dec-21 spreads in WTI, RB and HO Nymex futures.

By now, we are all familiar with what led to a recovery in prices and spreads since the end of April: production cuts. They were a remedy to pandemic-led demand destruction that was fairly well-received by the market. By the time we got to July, everyone was ready for a surge in demand to lead a supply-restricted market higher. Much to everyone's dismay, July was filled with demand disappointment. Capital flowed freely into tech darlings and metals driving them to new highs, yet energy markets were unable to attract interest. In fact, as oil poked it's head above the $40 level, money managers began reducing length. This speculative length is another form of 'inventory' that needs to be worked off.

This is always the case with energy in bear markets, especially a market that has just dealt with negative spot prices. We are now in a 'show-me' environment. As in, cash prices (aka spot prices) need to lead the market higher. Why is this? Because commodities like crude oil and refined products can be stored and this fact anchors future prices to spot prices despite short-term disconnects. This is why the selloff into negative territory was so brief. It took a hot minute for physical players to step in and 'arb-out' the storage arb, yet they finally did.

Negative prices 'happened', spreads blew out and we have since recovered. A chart of one-month calendar spreads over the last 8 months shows this narrative nicely.

Yet when we zoom in a little closer, we see that they have started to roll-over. It's one thing to find buyers at historical lows in spreads, its another thing altogether to turn those spreads positive. It takes more than 'not negative' spot prices to support a bullish narrative.

Spot prices hovering aimlessly around the $40 level for over a month do not prove-up a bullish case for spreads. It's also difficult to move spreads further into bearish territory simply via strength in the back of the curve. The back of the energy curve rarely leads. This is due to the fact that term energy markets are usually dominated by producer hedge selling rather than consumer hedge buying. Why? Because in general, large consumers of energy such as airlines hope to be naturally hedged by ticket prices that are elastic in their response to energy prices. Large producers of energy do not enjoy the same dynamic so they have to hedge (sell).

So we now have an environment where spot prices are not 'bad' but they aren't 'good' either. This is weighing on spreads further out on the curve. We see that the calendar 2021 vs 2022 spread started to lose steam this month (blue line below).

Yet, we do not expect a crazy sell-off in calendar spreads from here. There will be persistent weakness of course, but we are now entering hurricane season so front spreads are vulnerable to storm disruption headlines. It's just a frustrating scenario that needs a new headline to propel us in one direction or the other.

Refined Products

Gasoline and distillate were a mixed-bag for the month with the gasoline curve shifting lower in the front and higher in the back.

Meanwhile the 12-month strip in distillate ended the month higher across the board than where it began.

With inventories being above normal across the board, crack spreads have stalled while oil prices have tried to rally. Winter crack spreads continue to under pressure since the end of April, most notably distillate cracks that have been in a steady decline since the beginning of the year. The winter gasoline crack strip (Nov-Mar) is hovering around $5 as of Friday's close.

Lackluster spot prices for refined products are putting a lid on future buying. We don't expect this to change much until spot product prices become tight and lead the way.

Increasing Supply

As a final note, US crude production has been somewhat responsive to price. We saw production grow significantly when prices were above $50 and we have seen them contract as prices dropped below $50.

Now that we have made it to August, we will finally see the end to the deepest of the OPEC+ cuts. Production is set to increase out of those producers by around 2 million barrels per day (per the OPEC+ supply cut schedule below).

This could have an impact on the recovery of US crude oil exports (orange line below). Absent a robust demand recovery, this could make the global market be less able to absorb a rebound in US exports to pre-pandemic levels.

We think spreads will struggle to recover without material strength in spot prices. After all, it was spot prices that took the entire complex down, it will need to be spot prices that take the complex back up. Especially since inventory and speculative length will look to sell into strength.

Spot prices are holding at a level that make short positions vulnerable to short-term disruptions (geopolitical, climate or pandemic induced). This should lead to some contained ranges in calendar spreads until the end of the year while the world waits for a new headline to lead.


Weekly Changes

The EIA reported a total petroleum inventory DRAW of 9.40_million barrels for the week ending July 24, 2020. Crude oil alone posted a weekly DRAW of 10.60 (excluding SPR).

Year-to-date, total Inventory additions stand at a BUILD of 151.20 million barrels (vs 160.60 last week).

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


Resistance: 44.22 / 45.07 / 46.68

Support: 41.98 / 39.70 / 36.49

The Brent market will own its own bearish course this week. After failing to narrow the gap above which is now 45.07-46.68, the market should retrace back in the $30s. The Brent market has been struggling with a narrow range every week as well and will continue to do so unless it can break out on either side of 41.57 to 45.07. As we have maintained, a move back down is in the works at least towards the 39.70 level. Oct/Nov Brent rallied on Friday which put an end to its march to our objective to -.60 cents. Be leery if it can settle above -.34.


Resistance: 41.72 / 43.05 / 46.37

Support: 39.34 / 37.80 / 36.08

When I began tonight’s report, I wanted to make sure that I was not missing an obvious sign, a telltale signal, or just being too focused on the short side of the market. I do not think that I have. July was a slow month with respects to volume and excitement. The last five weeks have resulted in small trading ranges. For instance, there has not been a weekly crude range greater than $3.24 (dating back to June 29th). The market has tried to take this higher and its failed – the next objective should be the downside targets of 37.06 then 36.16 on the weekly chart. I am struggling to find a positive bias for the crude oil market.


Resistance: 1.1855 / 1.2195 / 1.2736

Support: 1.1524 / 1.1274 / 1.0943

Thursday’s rebound off the lows did not surprise many traders; but the continued rally for the remainder of the day sure did. We are looking for a test of 1.1274 this week. A break of that level, in our opinion, will surely take the balance of the energy complex with it. There is not much to speak about to the upside until it breeches 1.2736. Look for continued pressure on gasoline spreads, primarily Sep/Oct which should test 629 early in the week.


Resistance: 1.2408 / 1.2654 / 1.3023

Support: 1.2062 / 1.1846 / 1.1689

October Heating Oil tried sell off on Thursday only to rebound a bit on Friday. The heating oil market will not gather any momentum to the upside until it breaks above our resistance level of 1.3023. Every upside trendline in all four commodities have been broken. Although we could see a sideways market linger for weeks, there is little fundamental support to keep them even at these levels. Look for Sep/Oct heat to test to -176 then -195, if both those objectives are met then -248.

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