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Distillate Throws The Market a Lifeline

Author: Brynne Kelly (w/Lee Taylor technical levels-to return next week)

WTI and distillate calendar spreads rallied last week which contributed to strength in markets overall last week. In today's blog, we provide some perspective on this market strength.

The selloff earlier this year across the petroleum complex was followed by a fairly quick move off of the lows and then several months of sideways action.

This sideways action has been fairly uninspiring of late until last week when it looked as though distillate cracks were making another attempt to pull away from the group (cyan line above).

Weakness in the front of the market has been a trend all year. But, the rest of the curve is not necessarily being led by the front. Spreads in calendar 2021 HO/WTI are beginning to carve out their own path.

US distillate crack spreads vs WTI for calendar 2021 had been on a steady decline since the beginning of the year (blue line below). Surprisingly, during September the 2021 distillate crack spread dipped below the 2021 RBOB gasoline crack strip (brown line below) for several weeks.

Given historical patterns, this move weighed on oil markets heavily. It kept a lid on oil prices as refining margins for the combination of gasoline and distillate output hit combined lows. But, as of last week, distillate cracks are attempting to respond to the progress made in drawing down US distillate inventories.

Before getting too excited about this move, we take a look back at historical month-1 continuous crack spreads in distillate and gasoline (purple vs pink lines below) vs WTI month-1 continuous futures (black line below) since 2015.

This is a more sobering look at how depressed refining margins are at the moment. Clearly in the front, the recovery in oil prices has been greater than the recovery in refined product prices, hence, crack spreads are sitting at multi-year lows.

The shape of the distillate crack spread futures curve is decidedly in contango with more than a $4.00 difference between the Jan-21 and Dec-22 crack.

Looking at both the WTI and HO curves for calendar 2021 through 2022, we can see that both curves have made progress towards 'flattening' this month.

This can be seen via the spread between the front month (January-2021) and the back month (December-2022) in the chart below. The WTI spread closed at -$1.25 on Friday which is just over $.05 contango a month for the 24-month period ending December, 2022. This compares a contango of -$5.93 per barrel in the Nymex HO (ULSD) strip which comes out to an average of just under $0.50 contango per month for the 24 month spread. Both spreads have regained early-March levels in the spread, although to a lesser extent in the distillate market.

These all looks constructive, yet we are not sure this grind higher in both markets can really find legs until distillate spreads take the lead and gain ground on WTI spreads.

Distillate Inventory

The most positive news in the oil complex this month has been the fact that distillate inventories are finally drawing down. As of the November 13 EIA inventory data, distillate inventories are now below 2016 levels (gold line vs dashed blue line below).

The bulk of the inventory declines have come from PADDS 2-5 (right chart below), while East Coast (NYH-PADD 1) inventories still await significant draw-downs (left chart below).

This is the crux of the problem. The US East Coast has endured much stricter covid-19 lock-down restrictions than the rest of the country and it shows in the inventory numbers. Additionally, the US East Coast has enjoyed surprisingly warm November temperatures which has retarded East Coast heating demand. Should December weather return to seasonal or below-seasonal temperatures before refiners up their utilization rates, PADD 1 inventories could draw down quickly.

Key Charts To Watch Going Forward

Front-month winter spreads

Winter calendar spreads in crude oil and distillate. If there was ever a time for calendar spreads to show strength, it would be now - when production has been curtailed at historic levels to match the decline in demand. Discipline now could result in short-term tightness in supply. The front of the market under the current extreme production cuts could bite front spreads in the ass as distillate inventories are drawn down.


We continue to note the strength in Midland vs WTI spreads each week. When Midland is over WTI, oil is drawn towards the USGC, when Midland is below WTI barrels tend to back up at Cushing. This week we highlight the Midland/WTI spread vs weekly Cushing inventories. So far in November we have see month-1 Midland continue to trade over WTI in the face of builds at Cushing.

In fact, this month the entire Midland/WTI 8-month futures curve has shifted higher (increasing Midland premium over WTI).

While these are small shifts in the curve (up ~$0.30 in November), it is a shift higher as Cushing continues to report inventory builds. Why isn't more crude from Cushing moving south towards higher-priced USGC markets?


We spoke about the possibility of backwardation in the front of the WTI curve in last week's report. Calendar spreads were definitely strong last week, however it was the back of the curve (starting in January of 2022) that moved ever-so-slightly into backwardation. This is a bit of nonsense as the back of the curve rarely leads markets higher.

We see a similar shift higher in calendar 2021 distillate calendar spreads this month, but to a lesser extend than WTI in the back months (yellow line below).

Influencing Themes Going Forward

Covid-19 Vaccine

Over the weekend it was announced that the vaccine roll-out will begin in December for the highest risk group people (those above 75). This group has been the worst hit in terms of death rate so the hope is that we see this rate decline once this group is vaccinated. Relief for the most vulnerable population could go a long way towards relieving the need to lock-down entire areas.

Upcoming OPEC Meetings (as noted last week)

The next OPEC meeting will take place as follows:

November 30, 2020: The 180th Meeting of the OPEC Conference

December 1, 2020: The 12th OPEC and non-OPEC Ministerial Meeting

We think the most important guidance for OPEC will be refinery utilization rates. There is simply no need to increase production until refiners show signs of increased utilization. Increased utilization will be governed by crack spreads. Crack spreads are low, utilization rates are low. We don't think there will be much clarity regarding refinery utilization in the days leading up to the OPEC meeting. We don't see any other option for OPEC other than to extend cuts for another 3 months.

EIA Inventory Statistics

Weekly Changes

The EIA reported a total petroleum inventory DRAW of 2.20_million barrels for the week ending November 13, 2020 (compared to a draw of 3.90 million barrels last week).

YTD Changes

Year-to-date, total inventory additions stand at a BUILD of 43.20 million barrels (vs 45.40 last week).

Inventory Levels

Commercial Inventory levels of Crude Oil (ex-SPR) Gasoline and Distillate are slightly within their 5-year range (except for commercial crude oil inventory). This is frankly nothing to write home about.


Lee Taylor - Technical Levels

(To return next week....)

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