For the last 6 months, oil markets have experienced one supply disruption headline after another. Last week, markets faced one of the largest demand disruption headlines we've seen in quite some time, namely the Coronavirus.
Supply disruptions have been met with an immediate spike up in front-month futures only to be followed swiftly with a subsequent sell-off once the details and timing of such disruptions becomes known. The market seems to have an easier time of quantifying the effect, or lack thereof, when barrels are taken off of the market. The swift pullbacks, often to new lows, highlight the collective market narrative that supply growth and slowing demand are in a constant battle.
Enter the Coronavirus. Suddenly the market had to contend with an imminent demand disrupt-er as travel bans were put in place and flights to and from China were canceled around the world. Doing their part on the supply side, OPEC + announced it will hold a technical meeting February 4-5 to discuss the impact of the coronavirus on oil demand. Their intent is to determine whether or not the full ministerial meeting scheduled for March 5-6 should be moved forward.
The one consistency that has held in oil markets is the way that headline news impacts the term structure. Namely, supply disruptions increase backwardation, and demand disruptions deflate calendar spreads, as noted in the chart below.
The 12-month calendar spreads that widened so significantly with bullish news (month-2 vs month 15 above, blue & red lines) deflate just as quickly when front-month futures sell off (black line).
Most of the weakness in early January has been attributed to weakness in ULSD markets, driven by seasonal winter weakness in demand due to weather, as well as exuberant positioning ahead of IMO 2020. The next chart highlights the selloff in summer WTI to heat cracks using the April-September futures strips.
Note how wide the spread between the 2019 gasoline and heat cracks was even into expiration while the 2020 cracks closed out last week at almost parity to each other. This ends an almost 2 year run of the 2020 summer heat cracks trading at a fairly wide premium to 2020 gasoline cracks! Do not underestimate the significance of this. Relatively strong distillate markets have helped to 'imply' demand for crude oil. Yet, traditionally it's been summer gasoline cracks that pull up the 3:2:1 crack margins in the summer. As of Friday's close, the 3:2:1 crack spread is sitting near recent lows. This should mean that crude will be attached at the hip to movements in product markets going forward, meaning rallies in oil that are unmatched by products could push crack spreads towards 10-year lows, a move that would damage even the integrated oil equities.
We turn now to the CFTC commitment of trader's (COT) data. This isn't usually something we as fundamentalists spend a lot of time on, but with the recent slide in price and the slight reduction in the GSCI of WTI crude futures via the 2020 re-balance, we wanted to see how this was playing out in Open Interest numbers.
Total combined open interest in WTI and Brent Futures reported by the CFTC for the combined CME and ICE contracts show that positioning in Brent futures grew much more than WTI over the last year. Isolating that to just those positions reported by money managers we see the same pattern: relative open interest expansion in Brent futures vs WTI.
Prior to the US allowing crude oil exports, Brent prices were an indication of the marginal cost of imports, with the US being mostly a 'price-taker'. The growth in US supplies and export access to global markets has shifted the focus completely to one where Brent prices are now an indication of global demand that US supply can influence. While it might have been initially concluded that more funds would flow into US as source of supply, it seems via open interest figures, that in fact more money has moved into Brent than WTI, especially as prices have have sold off.
With the Brent/WTI futures spread in continuous decline as of late, it's clear that the market is betting on the relative strength in Brent vs WTI going forward.
To recap, many spreads are on or close to their lows (calendar spreads, cracks and oil benchmark spreads). Open interest is concentrated more heavily in Brent. The most obvious key to moving cracks and Brent/WTI spreads off of their lows would be for WTI prices to fall further. Otherwise, Brent and product prices need to take the lead in a rally.
Looking for signs of some support, or at the very least a reversal of the current selloff in oil prices, we note that the calendar 2022 & 2023 strips made an ever-so-slight-that-you-might-miss-it move off of its lows last week. An ever-so-slight rejection of that 'below $50" area. This could just be a settlement anomaly that far out on the curve. It could also be selling of front vs back spreads in anticipation of markets returning to contango.
We can see this 'contango' by isolating the Dec-21/Dec-23 spread separate from the calendar strip.
Last week, this spread once again dipped into contango territory as it has done many time this year. However, it's been making higher lows since last summer.
Bottom line, we once again find ourselves in the midst of a flat price selloff that is pressured in all directions. The market rejected the $50 level in WTI several times in 2019. Can it happen again?? History has proven that headline risk has a shelf-life.
The EIA inventory report for week ending January 24, 2020 reported a Total inventory BUILD of 3.40 million barrels with Crude oil making up the bulk of last week's build.
Year-to-date, this bring us to a Total Inventory build of 15.80 million barrels, while remaining relatively unchanged year-to-date in Crude Oil (+0.60).
Inventory LEVELS compared to this same week in previous years continue to show product inventories slightly above prior years with crude oil slightly below.