Author: Brynne Kelly 8/22/2021
The past few weeks have been defined by 'risk off' sentiment in the oil markets, as prices have been defeated by concerns over the delta variant, mixed activity statistics from China, a stronger currency, and the fear that the US central bank could taper rapidly. Consequently, risk premiums across the petroleum complex have moderated. The markets are now struggling to maintain their upside momentum, even though upside price targets (defined by key analysis earlier this year) have not yet been reached. Traders are now left to weigh those targets against the barrage of macro selling pressure that has ensued.
For some perspective as we head into next week, today's analysis attempts to provide a ruler by which current market levels can be evaluated. We break this down into 5 categories:
Curve Structure
Inventory Levels vs Price
Current Prices vs Historical Frequency
Commitment of Traders Data
Calendar Spreads
Curve Structure
The shape of the WTI curve (using the 2022-2026 time frame below) highlights the move lower, specifically in the front part of the curve. In fact, the curve structure has now lost all of the ground it had made since the beginning of May (pink line vs dark purple line). For perspective though, we use the curve shape and levels as of January 2020 as a guide - considered 'pre-pandemic' (orange line below). This was a time just before the massive loss of demand from lock-downs and subsequent record oil output cut by OPEC+ members.
The front of the curve now holds less than a $10 premium to January 2020 levels. The question being pondered is whether or not the risk premium belongs in the front of the curve or should be moved further out, given the fact that the front of the market is now facing a potential slow-down related to the new Delta Covid variant, while the back of the curve still carries the unknown risk of production growth or lack thereof.
Inventory Levels vs Price
The shape of the curve shown above has contributed to a drop in US inventory levels. Over enough time, persistent and elevated backwardation leads to inventory draws. Initially backwardation increased as demand recovered faster than production resumed from OPEC+ and the rest of the world.
Inventory levels themselves don't have a corresponding 'price', rather they have a 'price range', or a forward-looking bias. Weekly inventory statistics, taken over time, highlight a trend in inventory changes. As shown below, oil prices are generally stable during periods of stable inventory levels, and move dramatically when inventory levels are or are expected to move outside of their normal operating ranges.
Using data going back to 2010, it appears as though prices find a level of stability when inventories are in the sweet spot of around 1,050 million barrels (yellow shaded area below).
Note how quickly WTI prices are at sniffing out and reacting to an expected change in the trend of inventory levels (black line vs blue line). Yet, as of last week's EIA data, the decline in overall inventory levels have plateaued while prices declined. The market is acting as though inventory is setting up for another leg higher (build). In reality, though, prices are at the low end of the range of where they have been historically at these inventory levels. Something to pay attention to.
Current Prices vs Historical Price Frequency
Without getting too fancy let's look at where current prices, spreads and inventory levels fall within their frequency distribution of prices since 2010 (green dots = current levels). We are not suggesting any specific conclusion from these other than to note historical occurrences relative to the current market and the fact that we are not currently in outlier territory,.
Price Distribution
The chart on the left below depicts the frequency distribution (shape) of continuous WTI futures and the chart on the right depicts the frequency distribution of continuous 12-month WTI calendar spreads. Current price levels are show on each diagram (green dot).
Inventory Distribution
The frequency of inventory levels is shown for both total US crude oil inventories (left chart) and Cushing inventories (right chart) below. Again, current levels are depicted by the green dots on each chart.
Commitment of Traders Data
The latest figures from the Commitment of Traders data through August 17 reveal that large speculators, and particularly systematic funds, have dramatically reduced their “long” oil futures exposure in recent weeks (shown below). In fact, the combined net managed money position for ICE and Nymex WTI now looks fairly benign by most metrics, especially in light of the still strong positive roll-yield currently implied by the forward curves.
This selling pressure from 'speculators' is not only putting pressure on front month futures, but also along the term structure. This can be seen via the comparison to the WTI calendar 2022 futures strip, which stuck out like a sore thumb in the data for money managers (aka, speculators) that include data through August 17 (black line vs blue line below). By Friday's close, a mere 3 days later, the calendar 2022 strip lost it's battle to stay above the $60 level (green dot below).
Calendar Spreads
It's amazing how quickly the backwardation in oil markets has collapsed. As of last Friday, only the Oct/Nov and Nov/Dec time spreads are trading above where they were at the beginning of 2020.
As noted earlier, this backwardated structure provides an incentive for storage draws in the short term. What muddies the waters on this yardstick at the moment is the amount of production still being withheld from the market. But, with US Cushing inventory levels skewed towards the lower end of their range (as noted in frequency distributions earlier), it is plausible that the market may want to remove some of the incentive to withdraw further inventory, hence the collapse in calendar spreads. However, lower inventory levels also make the spot market vulnerable to short-term supply disruptions due to weather or logistical outages. Regardless, draws in inventory this year have certainly put the complex better prepared for another potential swift drop in demand.
Longer-dated spreads, such as the 12-month Dec/Dec, have also pulled back significantly from their peak (without surpassing the highs made in 2019). There is still some fat on that bone though, especially if you subscribe to the theory that the front of the market contains more risk to the downside if the delta variant causes more widespread lockdowns. Additionally, storage owners may begin to husband inventory, especially at Cushing if they feel they will be unable to replace them easily in the future. If this sentiment takes hold, there is a lot of room to the downside here still.
There are so many factors that are shaking up the international crude markets this year. We live in a time where there are more moving parts to consider than traditional models can handle, including government-imposed restrictions that significantly impact demand, uncertainty in global politics, and commitments to climate goals whose deadlines are fast approaching.
If sentiment is truly shifting towards the downside, we hope the above provides a guide to potential downside moves. If the last few weeks have merely been liquidation of speculator length, then we may have reached some support levels based on fundamental and historical data.
_______________________________________________________________________
EIA Inventory Statistics Recap
Weekly Changes
The EIA reported a total petroleum inventory DRAW of 5.30 for the week ending August 13, 2021 (vs a net of 0 last week).
YTD Changes
Year-to-date cumulative changes in inventory for 2021 are DOWN by 100.20 million barrels (vs down 94.90 million last week).
Inventory Levels
Commercial Inventory levels of Crude Oil (ex-SPR) compared to prior years are have gone from way above historical levels to slightly below historical levels and should continue to draw as long as backwardation in the market persists.
