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Crude Oil: It's All About Relationships

Author: Brynne Kelly 5/02/2021

Despite analysts and oil forecasters upwardly revising their 2021 oil price and demand outlooks, market participants are waiting for further directional cues from the physical market to confirm. With outright prices at or near recent highs, it's reasonable to see if there are laggards in the complex that might hold us back from taking another leg higher. Where might we find such directional cues? The answer is in relationships. As long as price relationships across the complex are in-line, prices will be supported. Any significant weakening of a key relationship would be a sign that the market needs to correct.

Key Relationships

- Crack Spreads

- Inventory

- Crude Oil Arbs

- Strength/Weakness of front calendar spread into expiration

While a deep dive into each of these would yield their own granular relationships, taking a holistic view of these four relationships provides a good summary of the embedded intricacies.


Weakness in refining cracks is an age-old sign of a loose market, either from excess inventory or anemic demand, or both. It's also a way to keep crude oil prices in check. Refined product prices reflect end-user demand and, as we saw last year, refiners were the first to respond to the demand shock and negative margins by drastically reducing their utilization. While there is some baseload of operations that will run despite economics, the marginal refiner is a capitalist. In an ideal world, refiners would opt for relatively low oil prices (less working capital required) in an environment where refined product demand is relatively tight. They will settle for decent spread margins, however, regardless of high oil prices.

So, as oil prices have pierced above the $60-level, have crack spreads kept pace or lagged (which would be a sign that the oil price rally may have gotten ahead of itself or that the premise of the rally is faulty)? The first place we look towards is US gasoline and distillate crack spreads versus Brent (the more relevant benchmark to align with the NY Harbor refined product futures markets).

ULSD cracks had been trading in a range of $15-$20 prior to the pandemic meltdown in 2020. Not only have distillate cracks managed to rally alongside oil prices, they have also attempted to regain their old trading range three months out (dark purple line below). As of the most recent EIA inventory report, refiners are currently running at 85.4 % capacity. This opens the door for some potential short-term weakness in crack spreads if utilization rates pick up and oil markets are tight. Eventually, If demand is there to meet the increased output, crack spreads will stabilize and should regain the $15 level.

Moving on to gasoline cracks, we turn to the NY Harbor RBOB vs Brent crude oil crack spread relationship (below). Like it's counterpart in ULSD, gasoline cracks vs Brent are not only keeping pace, but outperforming. The most recent trading range for the continuous front 3 contracts has been between $15-$20 prior to the pandemic. For the last several weeks, gasoline vs Brent cracks have been flirting with new highs. Should we fail to realize these levels into delivery, this could be a sign that the market may have gotten ahead of itself and has mispriced the recovery.

We see a similar pattern, of course, in the product relationships to WTI. In the case below, the comparison is made to WTI based on a rolling 12-month strip to deepen the relationship. What's notable is that since Q4 of last year, cracks vs WTI have doubled (from $10 to $20) while WTI prices are up just over 30% (from $40 to $63). On a 12-month strip basis, gasoline cracks are at the top end of their range while distillate cracks have been unable to regain 2019 levels.

Should distillate markets firm this summer, they will underpin another move up in oil prices. Should they weaken significantly, it will be a drag on the overall market. At the moment, cracks are supportive of the oil rally.

Earlier this year, naphtha drew a lot of strength from robust petrochemicals demand, which tightened supplies. Naphtha generally trades at a discount to crude oil (i.e. negative crack spread) since refiners target a maximization of their yields of premium fuels (diesel or gasoline). Earlier this year European naphtha actually managed to trade at a premium to Brent. This has since subsided and returned to more traditional ranges with a bit of strengthening of the curve over the last 10 days as seen below.

Light naphtha can refer to either a finished product used as a petrochemical feedstock or a distillation cut commonly called light straight run naphtha. It is composed of pentane and slightly heavier material. In a refinery, light naphtha is often blended directly into gasoline. However, its low octane and relatively high vapor pressure typically limit it to 5% or less of the gasoline pool. To boost its octane, it is often sent to the isomerization unit before gasoline blending. To see a rally in naphtha cracks in step with a rise in gasoline cracks is supportive.


As a result of both recovering demand and low US refinery production, inventories of gasoline have plummeted below their 5-year seasonal lows (yellow line vs black line below). Seasonally, the summer driving months correspond to overall declines in gasoline inventory from now until the fourth quarter. The market currently expects summer driving demand to be robust and inventories to continue to decline ahead of refiners increasing output. Should gasoline inventories start to build and rise above their 5-year average, it could become a warning sign that the fundamentals that have underpinned the rally in WTI to $65 are waning.

US distillate inventories have also managed to retreat towards their 5-year average. Seasonally, in the summer, the US builds distillate inventory in preparation for winter usage. As long as inventory levels remain near their 5-year average this summer, distillate prices should not come under much pressure, especially if jet fuel demand were to increase. This would redirect refined molecules from the distillate pool to the jet fuel pool and be supportive of ULSD prices.

Finally, based on last week's EIA inventory report, US commercial crude oil inventory levels are back at their 5-year average (gold line vs black line below). Seasonally, oil inventories decline from now through the end of summer (similar to gasoline seasonality).

Current market prices appear to be pricing in a return to seasonal patterns. This explains the consolidation that continues to happen every time we make new highs. For prices to continue higher from here, future EIA data will need to show seasonal declines greater than the 5-year average.


Nothing says robust demand better than global crude oil spreads that are supportive of the movement of oil through the system. This means that the market spread between oil grades and locations is sufficient to cover the cost of transport plus some margin. One of the key spreads used to highlight this dynamic is the WTI/Brent spread, and even more specifically, WTI at Houston vs Brent.

To get a sense of the landscape, the chart below compares the aforementioned oil spreads to tanker shipping costs for the USGC - UK shipping route (using CME USGC to UK dirty freight futures, dotted red line below).

It's not enough to look only at the generic WTI/Brent futures spread (black line above) because it represents US barrels at Cushing, OK that still need to get the the US Gulf Coast for export. The more relevant comparison is between WTI at Houston and Brent to see if the 'arb' is open to export marginal barrels (WTI/Brent spread less tanker rates). This 'back of the envelope' comparison does not include additional costs that need to be factored in such as time delays, bunker fuel costs or additional loading/unloading fees. With that in mind, the data in the chart above reveals how slim the spread margin really is once you back out freight (pink line vs red line above). In fact, Q4 futures show that the spread between WTI-Houston and Brent is a mere $0.40 above freight futures. This is something to watch as the Q4 arb may need to widen out even if tanker rates remain the same. The fourth quarter is typically laden with refinery maintenance, so at the moment, a weaker Q4 arb isn't much of a signal.


Waiting for the spot market in crude oil to tighten has proven to be a waiting game as cash prices continue to trade at a discount to futures in WTI. The structure of the futures curve is that of backwardation, and timing. As in, the market is trying to time the exact pinch point in the supply/demand recovery and place spread bets accordingly.

This is evident in the chart above which depicts the shift in WTI calendar spreads over the last 10 days. There is not much notable about a $0.25 monthly backwardation in the longer-dated part of the curve as this merely reflects the tone of the overall market. What is somewhat notable however, is the trend of front spread weakness into expiration. They remain vulnerable to fears of rising virus cases in key demand countries like India.

As of last Friday's settle, the widest 1-month spread shifted from the Sep-21/Oct-21 tenor to the Oct-21/Nov-21 tenor (gold line above). Meanwhile, the front spread has barely managed to claw it's way back above $0.00. At some point the market is going to need to see a significant positive cash roll in order to sustain future spreads. Monthly convenience yields are still high and favor owning physical assets (see last weeks report) to take advantage of short-term spikes in prices.

On balance, each of these four relationships are holding their own against the backdrop of rising prices.

Of Note This Week

- Saudi lifts suspension on citizens travelling abroad and opens land, sea, air borders as of Monday, May 17.

- UAE's ADNOC sets June Murban crude OSP at $63.35/bbl.

- Enbridge Line 5 is supposed to close by May 13, according to Michigan’s governor, to eliminate the risk of a major leak


EIA Inventory Statistics Recap

Weekly Changes

The EIA reported a total petroleum inventory DRAW of 4.60 million barrels for the week ending April 23, 2021 (vs a draw of 1.20 million barrels last week).

YTD Changes

Year-to-date total inventories in 2021 are DOWN by 7.00 million barrels (vs down 16.70 million last week).

Inventory Levels

Commercial Inventory levels of Crude Oil (ex-SPR) compared to prior years reflect progress that has been made in reducing excess inventory levels.


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