Author: Brynne Kelly
From an extreme selloff to an epic recovery, 2020 will go down as one of the most volatile in history. This has created one of the most difficult-to-predict fundamental puzzles the market has had to deal with in a long time. Traditionally, energy curves have taken their cue in front of the market by applying a modified version of today's conditions into the future. Now that the initial panic has subsided, it's time to ponder whether the back of the market can decouple from the front in a meaningful way.
Gasoline
Since the initial collapse in prices due to the world-wide pandemic that led to an unprecedented halt in global demand, US gasoline futures made a valiant attempt to move back towards normalized levels. In US dollars per barrel, gasoline prices managed to rebound towards previous low levels last seen at the end of 2018.
This was due in part to supportive gasoline inventory draws since their peak on April 17, 2020 of nearly 8 million barrels (black line below).
What was encouraging about this was the fact that inventories were able to maintain below peak levels while refiners steadily increased production since the April 17 lows by almost 3.3 million barrels per day. With little concrete data regarding how a recovery will play out, this was seen as evidence that US driving activity had picked up and there was end-user demand for increased output without overwhelming inventory. Then the bad news hit last week that virus cases were spiking in southern states and some elements of their phased recovery were put on hold.
Cue a sell-off in gasoline prices and gasoline crack spreads.
It's reasonable that any recovery in front spreads would take a hit with this news. What was a bit more disturbing was the fact that summer gasoline cracks to WTI for 2021 and 2022 also broke down as if we may never recover. But, we have to ask ourselves, is this is one of those times where the bearish scenario that exists currently may not be a great signal for future market conditions? Meaning that the sluggish end-user demand in 2020 could lead to shortages in the future. As in "what happens to the front of the market doesn't have to happen to the back of the market".
Let's look at what happened to summer gasoline crack spreads in 2021 and 2022. They also sold off. Is the market saying that excess gasoline inventories will persist? Further, does the market expect that gasoline demand worldwide will remain so depressed that the US will not be able to find a home for the gasoline it produces globally? As it stands now, Brent prices are roughly $3.00-$3.50 higher than WTI in calendar 2021-2022, making refinery margins for gasoline in the US Gulf Coast closer to $9.00 in summer 2021 and 2022 (RB/WTI crack spread of $12 less the $3 Brent premium). This is where the trading opportunities lie, to pick up future spreads that are moving in sympathy with the front.
Expecting refining margins 1 to 2 years out to mimic those experienced during a global pandemic is a knee-jerk reaction, absent data of a structural, long-term change.
One of the factors currently influencing weakness in spot gasoline markets is weak NGL prices (green line below).
Specifically, the NGL's used as gasoline blending components: N. Gasoline, Normal Butane and Iso-Butane are being driven by weak gasoline demand. While it's normal to see a decline in butane prices in the summer (due to summer gasoline RVP specs that reduce demand for higher RVP components like butane and natural gasoline), this decline is unprecedented.
However, even with the backdrop of lower NGL blending demand for summer gasoline blends, the spread between RBOB gasoline and normal butane (a widely known 'uplift' for NGL's like butane) is low by historical standards suggesting that the summer gasoline 'pool' is full. Until those summer gasoline inventories are reduced, NGL's will remain weak and back-up in inventory awaiting input into the winter gasoline pool.
Lower NGL prices will lead to further reductions in NGL processing plant investment and lead to future shortages. Another example of where current price weakness may not justify selloffs in next summer and beyond prices.
WTI
Another casualty of the pandemic has been one month calendar spreads in WTI. The front of the market dropped quickly into severe contango. We see similar, but much less pronounced action in the 2021 calendar spreads. The swing from backwardation in January to contango was much less pronounced in this part of the curve (from a high of $0.40 in early 2020 to a low of around -$0.68 in April). The question everyone is asking themselves now is "when, or if calendar spreads regain a backwardated structure".
Rather than focus on a particular monthly spread, it's easier to divide the years up into the first 6 months (first half) vs the second 6 months (2nd half) for comparison. For 2021, the spread between the 2 'halves' fell almost $5.00 from their highs in early 2020 before recovering. As we receive more clarity on the impact that declining rig counts and reduced capital expenditures will have on future supply, the 2021 spread (blue line) should be the first-mover. Remember that the OPEC+ supply cuts are scheduled to last through the end of 2021. How quickly could they vanish if the market becomes tight?
The convergence of spreads due to a lack of forward guidance is evident in the next chart of spreads between calendar strips. The balance of 2020 (August-December, green line) spread to calendar 2021 recovered from it's April lows and now seems to be setting the tone for all future spreads between calendar strips.
We do not think that the remainder of 2020 spread to anything can be relied on as a leader anymore. In fact, expect it to decouple from future spreads because it's impossible to ignore the impact of the overhang in oil inventory in the short-term. Commercial US crude oil inventories are at all-time highs. Projections for future capital expenditures continue to be revised lower. Spending won't improve until prices improve, and prices can't improve until inventories are lower. Therefore, we'd rather bet on the calendar 2021/2022 or 2022/2023 spread moving into backwardation than 2020 spreads.
Gasoline and WTI spreads are two of many examples where the entire curve has moved in reaction to the current conditions we face due to the global pandemic. We expect the noise to continue and for the front of the market to take a back seat to future spreads.
Inventory Recap
Weekly Changes
The EIA reported a small total inventory BUILD of 1.90_million barrels for the week ending June 19, 2020. Once again, Cushing inventories posted a draw and the US Strategic Petroleum Reserve posted a build (movement FROM Cushing TO the US Gulf Coast). Crude oil alone posted another weekly build of 1.40 (excluding SPR).
Year-to-date, Total Inventory additions continue to hit new highs each week and now stand at a record YTD BUILD of 167.70 million barrels (vs 165.80 last week).
Commercial Inventory levels of Crude Oil (ex-SPR) and Refined Products are still above those seen in prior years for the same week ending (except those at Cushing).
Lee Taylor - Technical Levels
BRENT
Resistance: 42.22 / 45.18 / 48.40
Support: 39.69 / 36.49 / 34.16
Moving on to the September contract, since August expires this week, we find more gaps left above in the Brent contract. A break under the 39.69 early in the week could signal a quick $3.00 move down to 36.49. Resistance is easy to find as one can just focus on the gaps above – we find the same gap in the weekly chart as we do the daily continuation which is 43.97- 45.17. If flat price becomes heavy, look for Sep/Oct Brent to retest -.12 before it heads back to flat.
WTI
Resistance: 39.76 / 41.08 / 43.85
Support: 37.54 / 36.35 / 34.70
Most technicians are trying to find that magic number that will give them the clue to our next big move. We have all been looking at the closing of the “Covid-gaps” left wide open above the market back in March. The speculation has been filling the gap and any shorts left in the market will cover and take us up to the next level. Unfortunately, that has not been the case – in fact, almost the opposite has occurred. It happened last week in the weekly continuations chart when it filled the gap up to 41.05 and then almost retraced back to our level of 36.16. There is still a gap left in the August CL daily chart between 41.63 to 42.17 – when and if we get back up there, let's see if the last gap filled will the hold the key.
RBOB
Resistance: 1.1832 / 1.2031 / 1.2751
Support: 1.1016 / 1.0739 / 1.0512
As we have discussed, the gasoline market was overbought based upon the RSI and appeared to have fixed that issue late last week. Most of the RBOB spreads took a beating last week – they should open around key support levels for each one – Sep/Oct (714), Oct/Nov (125) and Nov/Dec (55).
HEATING OIL
Resistance: 1.1841 / 1.2104 / 1.2986
Support: 1.1328 / 1.0709 / 1.0611
August Heating retraced all last week after leading the complex for most of June. August HO needs to hold and settle above 1.1328; if not, a move to 1.0709 is in the works. We may see a pop in Aug/Sep Heat to -208 but looking more for a move down to -290 and even possibly -334.