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Saudi Trip Yields Little: Distillate Seasonality Takes Center Stage

Author: Brynne Kelly 7/17/2022

Biden's trip to the Middle East has concluded. Conflicting headlines followed, providing little clarity of next steps. Headlines out of both camps played to their respective home crowds. We asked ourselves three questions as we read the comments looking for clues. Here is a snapshot.

1- How did the discussions go?

  • Biden: I had an excellent discussion about securing global energy security and adequate oil supplies.

  • Saudi Minister: There was no discussion of oil production at the Jeddah summit.

2- Do both parties appear to be on the same page diplomatically?

  • Biden: I anticipate that Saudi Arabia will take further energy-related moves in the coming weeks.

  • Saudi Crown Prince Mohammed: Adoption of unrealistic policies regarding energy sources will lead to inflation.

3- Were the Saudi's easily persuaded to increase production?

  • WH Econ. Adviser Bernstein: There is room for Gulf producers to increase supply.

  • Saudi's Foreign Minister al-Jubeir: OPEC+ will continue to monitor market conditions and do what is necessary, and that we are in constant communication with the US about that

Bottom line: Saudi Arabia gave the US no concrete commitments on boosting oil output. Further, Biden appears to be in a troubled position, unable to walk away from the trip with a concrete win. We have seen this before, and while both leaders played to their home press for political purposes (with Biden appearing the least convincing) when push comes to shove oil may still be freely pumped, but not without a high price to the US; and certainly no public Saudi prostration by MBS to the West.

With the imminent headline risk from that trip behind us, we can get back to focusing on what is in front of us.

Over the last 2 weeks, oil futures have been hit with paper selling as large macro risks began to dominate. These risks included US dollar strength, fresh pandemic lock-downs in certain areas of the world and inflation-induced recession fears. This selling pressure forced bulls to reevaluate their positions.

Initially, calendar spreads held their ground as flat price retreated. This dynamic at first provided bulls with some reassurance that pullbacks in outright prices aren't impacting the strong fundamental sentiment that strong backwardation implies. But, by the beginning of last week, even calendar spreads began to come under pressure. This lead traders to seriously question whether there are now cracks in fundamentals, or if the supply side story is still intact, but the demand destruction from Fed policy was starting to become realized. By the end of last week, however, spreads staged a recovery even as outright futures in WTI were now below $100.

It appears that with the Saudi summit behind it, the markets can now focus on the fall/winter season and the looming cessation of SPR drawdowns. Some macro selling hit oil and no doubt trading books will keep squaring up this coming week. But overall traders are now turning their attention away from the 'now' and towards the next seasonal play which is winter heating season.


Last week we noted that calendar spreads are being used as a focal point of the supply problem in the weekly post entitled: Oil Spreads at Record Highs: However, Time is Running Out

We have not witnessed spreads such as these at levels this high. Neither have we seen them persist at such high levels this close to expiration. Said another way, time is running out for the market to make a decision one way or another, barring some sort of new material event.

This week we look beyond the expiration of summer season oil spreads to the upcoming winter season. To do this we focus on distillate markets (aka, heating oil).

There has been no shortage of headlines suggesting that supply issues could reach crisis levels this winter (first it was this summer, now it's this winter). For example, German news outlets continue to report that "Germany Won't Survive Winter Without Russian NatGas".

Winter in the US is traditionally defined as the period between November through March. This prompted us to took at two seasonal calendar spreads in US heating oil markets: Shoulder to peak (Oct/Jan) and Peak to Shoulder (Jan/Mar).

Shoulder to Peak

Taking the Oct/Jan calendar spread first, one would intuitively expect that a shoulder month such as October wouldn't hold much of a candle to it's peak demand rival January. Depending on the dynamics heading in to the fall refining maintenance season, this spread typically runs either side of zero with the preference being to store fall barrels away for use in the winter. Nuanced dynamics such as the veracity of summer hurricane damage and the level of storage ahead of winter can tip the scale on either side of the zero level.

A look at a chart of the Oct/Jan spread in US heating oil futures over the last few years bears this out...

However, what a shock when we add this year's Oct/Jan spread to that chart:

What happened to seasonality? It appears as though traditional seasonal relationships aren't even a factor this year. Rather traders seem to be more worried about fall 'refining' capability than they are about seasonality.

Said another way, reliable seasonal relationships have been repealed for now. In fact, we are so far away from the norm that it's impossible to reliably handicap such a spread. The market almost incredulously implies traders are more worried about the shoulder heating oil season than the peak of heating oil season (which falls in January and February). Such backwardation in this spread begs the question: How bad are this year's fall refinery maintenance outages expected to be? It's an especially odd question given that the White House has continued to state it has asked refiners to delay, if possible, any planned outages to next year.

Peak to Shoulder

Speaking of next year, we turn to another seasonal relationship in heating oil markets which is the relationship between a peak heating oil demand month and the next shoulder demand month: January versus April. The expectation being that a peak demand month will hold more value than the next shoulder (lower) demand month.

The accompanying chart (crazy but in a normal way?) bears that relationship out...

In recent history, January has held higher value than April. The seasonal relationship this year, however is much more exaggerated. Again, difficult to handicap where we go from here.

The market is clearly determined to secure refined product ahead of this winter, but the exaggerated nature of seasonal spreads in heating oil are sure to come in to focus. Will fear or fundamentals win out?

Outright Heating Oil Futures

To round this discussion out, we look at the performance of heating oil futures over the last 18 months.

There has been a lot of press regarding the 'pullback' in energy prices recently. But, when viewed in context above, we have seen a 125% increase in 2023-2024 futures prices since the beginning of 2021. The pullback since the highs recorded last month, in contrast, has only been about 6%. Not a very meaningful pullback if you are a consumer.

So, while oil prices continue to digest post-meeting macro selling and the impact of Strategic Petroleum Reserves hitting the market for another two months, this isn't yet translating to heating oil - a key product needed this winter.

Bottom Line

Meeting Over, Macro Sellers, Seasonal Focus

The petroleum complex can now put the Saudi Summit in its rear-view mirror and refocus on the supply/demand dynamics driving these markets. On the supply side, the physical shortage is still very real and markets had been priced to (the polar opposite of) perfection headed into the Biden/ MBS meeting.

The only remaining wild card from that is the actual pumping the Saudis actually do, political posturing aside. On the demand side, we have potential demand destruction by Federal Reserve tightening policies. But the most important thing for now is the seasonal switchover coinciding with SPR drawdowns stopping and subsequent shortfall. Without that, we will have a hard time treading water this winter if a cold one comes. All that said, oil did bounce nicely Friday, but finished down on the week.


EIA Inventory Recap - Week Ending 7/08/2022

Weekly Changes

The EIA reported a total petroleum inventory BUILD of 4.90 for the week ending July 8, 2022. Commercial inventories rose again by 3.30.

YTD Changes

YTD total petroleum EIA inventory changes show a DRAW of 120.20 through the week ending July 8, 2022.

Inventory Levels

Commercial Inventory levels of Crude Oil (ex-SPR) compared to prior years are have gone from way above historical levels to surprisingly below historical levels and should continue to flounder while backwardation in the market persists.


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