Timing the "Recovery"
Outright prices and spreads across the petroleum complex are trying to place a value on current circumstances and their impact on the future. Two familiar charts in our posts this year have been those that show calendar strips and calendar spreads. We again turn to those to set the stage.
The most pressing impact on the complex has been and continues to be the accumulation of inventory caused by the severe slow-down in demand. Producers of goods and services are on opposite ends of the spectrum during this crisis. 'Service' providers can't readily store their unused capacity in the same way the 'Goods' providers can. In that way, the two will have dramatically different recoveries.
Service providers will meet this crisis with layoffs. Goods providers will meet this crisis with a build-up in inventory. A return of demand for services requires a call on service providers that requires lead-time. A return of demand for goods can be met by stored inventory. The size of that inventory will dictate the voracity of any price recovery.
With that in mind, we look at petroleum inventories.
The normal cycle of gasoline storage has been one where inventories reach their peak around February as refiners build their stash ahead of the US summer driving season and then begin to draw down until they hit their lowest levels of the year around November.
As the preceding chart shows, the US was on track to repeat this pattern in 2020 as inventories hit their peak in February and then began drawing down through March 20. But when stay-at-home orders began to take effect and driving came to a halt, they made an abrupt reversal. Consequently, as of April 10, US gasoline inventory levels now sit at record high levels. In response, US refiners began reducing throughput and refinery runs went from a high of close to 90% in January to just under 70% by April 10. Future EIA inventory reports will reveal if this reduction in gasoline output is enough to stem record-pace inventory growth or if further reductions in refinery runs are needed.
The Sensitivity of Demand Recovery
In the tables below are two various recovery scenarios (there are so many recovery scenarios that all we want to do is point out the sensitivity of one versus the other from which you might be able to calibrate your own models).
The sensitivity of the future is tied to the amount of inventory builds, and that cannot be underestimated. Using the most basic of assumptions (refinery utilization rate), we can derive the impact on inventory levels going forward.
Historical quarterly utilization rates vs. the projected shape of the recovery:
Historical quarterly inventory changes as a result of refinery utilization rates:
First, we look at quarterly inventory changes. The general theme historically has been that crude oil inventories build in the first quarter and draw in the third and are generally flat in the second and fourth quarters (using 2007-2019 averages). On balance, over time, inventories are flat year to year. UNLESS there is an anomaly. We had an anomaly in 2015 where total inventories increased by 102,127 million barrels as US shale oil production began in earnest. Three and a half years of OPEC inventory cuts later and we have still not worked off that inventory build.
In both Scenario 1 and Scenario 2 numbers above, the commonalities are:
- US Oil production is reduced economically by roughly 1.5 million barrels from January 2020 levels and remains at those levels with no growth.
- US Operational Refiner Capacity remains the same at 18.808 million barrels per day.
Holding those two inputs stable, we simply increase the level and shape of refinery utilization. Scenario 1 assumes the rapid recovery of demand, thus the need for refinery outputs resumes during the 3rd quarter of 2020. Scenario 2 assumes a more muted demand recovery that does not begin until the 4th quarter of 2020. Both scenarios assume the same inventory builds in the second quarter of 2020 (which is on pace for a 13 million barrel build per week).
These are simple assumptions that we do not impact by price levels and debt maturities. They are meant to highlight conditions that need to be 'rectified' by price. Both scenarios are shown played out below via inventory builds/draws and compared to US inventory capacity (dashed green line vs dashed orange line). Given that it's unrealistic to fill storage to 100% capacity (some must remain available for receiving new deliveries, tank-to-tank transfers, blending, and other routine operations), we also provide a 90% of capacity line (dashed grey line).
Scenario 2 highlights the impact of simply shifting the return of refinery utilization rates from Q3 to Q4. Under scenario 2, US crude oil inventories will hover around maximum storage levels for years barring any significant return of refined products demand in excess of production capacity (remembering that builds in gasoline inventories need to be worked off first!!).
With all of that in mind, we turn to WTI calendar spreads that have been completely weighted down by simply receiving this excess daily over-supply.
These spreads are clearly exceeding the cost to store. They are trying to send a message: There will be no room at the Inn....store at your own risk. Meaning that normally spreads move towards the cost of storage, they have moved beyond that.
Back to timing the recovery. Arguments could be made that support both scenarios illustrated above. Is there enough pent-up demand ready to cut loose as states and major metropolitan areas ease shutdown rules to rapidly soak up the oversupply created or should we assume a slower recovery lasting through Q3 and nothing really gains traction until Q4. Even then can we expect the pent-up demand to meet or exceed historical levels enough to right the supply/demand imbalance faster than anticipated?
Perhaps this is not about the timing of a demand recovery at all. Perhaps it's about outright prices once and for all moving relentlessly lower bringing bankruptcies forward and forcing producers' hands? Analysis presented lately suggests that producer debt obligations don't hit their peak until late 2020 and beyond. Is the market seeing the inventory build-up as something that is insurmountable and driving front month prices lower in order to bring the inevitable forward? In that case, calendar spreads will remain under significant pressure regardless of storage economics.
US inventory levels vs total storage capacity:
The EIA reported a total inventory BUILD of 19.30 million barrels for the week ending April 10, 2020.
Year-to-date, this bring us to a Total Inventory BUILD of a record 72.60 million barrels!
Inventory levels are shown below, compared to prior year levels for the same week ending as well as against total storage capacity.
Lee Taylor - Technical Levels
Resistance: 29.00 / 30.67 / 32.54
Support: 27.20 / 26.28 / 24.52
I still maintain that the Brent market is technically sounder than WTI. However, technically sound and poised for a rally are two completely different topics. The support levels underneath are firm and have given the Brent market its foundation, however we have seen the swings in this market and they can be make the level vanish rapidly. We were wrong in our belief that June/Dec Brent could hold some support levels. Our numbers were spot on with a break of -7.18 heading to -8.16; but now look for -8.16 to become resistance and for this spread to swing between -11.34 and -8.16.
Resistance: 25.44 / 26.53 / 27.34
Support: 24.06 / 22.74 / 21.64
One thing is surely apparent and that is last week’s “historic” OPEC meeting was slightly overblown. We didn’t have to worry about our resistance level as they were never in play. Let’s focus our attention to June WTI, since May goes off the board on Tuesday. June WTI reached a high of 33.15 on April 9th but seems to be a path towards 21.64. After the big collapse last week, we should see a bit of short covering early but keep those resistance levels in hand as the rally won’t last long. Look to sell any rally in June/July WTI as it nears -453.
Resistance: .7343 / .7668 / .8536
Support: .6711 / .6405 / .5809
RBOB is the most intriguing market in the energy complex right now. Such disparities between perception and realities. Tough ceiling above the market beginning at .7343 and even stronger at .7668. Based on a relative strength index, gasoline is breathing slightly easier, however I think the market will begin another test of the downside. June/Dec RBOB may be the best indicator here as it is nearing -378 resistance with support at -579.
Resistance: .9880 / 1.0029 / 1.0147
Support: .9355 / .8976 / .8605
It was hard for any support numbers to hold last week amid the major sell-off. I don’t envision a smart play on the June/July spread. If May heating oil is unable to stabilize this week, we could see a retest of its low set back in early 2016 of .8605. June/July is flirting with resistance at - .386, upside is short-lived to -.347 but the short side could pay off as support comes in at -442 then -514.