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Who is Driving the Bus?

Updated: Jun 26, 2020

Author: Brynne Kelly

More often than not, oil markets cling to a singular, overriding narrative that seems to drive price movements. Lately these drivers are incredibly conflicting. Today we take a look at 6 key factors at odds vying for leadership:

  1. Inventory

  2. Production

  3. Refinery Demand

  4. Global Demand

  5. Currencies

  6. Positioning


The most visible driver in oil markets is inventory. Record inventory levels are becoming old news and many have turned their attention towards declining production in the face of recovering demand. It's not necessarily that easy to work off excess inventory. Prior to 2015, annual changes in US commercial crude oil inventories were fairly benign.

Then came 2015 with record inventory builds and a major sell-off in oil prices. It took a concerted OPEC production cut for almost 3 years to finally bring the system back in to balance in 2019. Cut to 2020 and the fact that commercial oil inventory builds have already surpassed those seen in 2015. Inventory levels have also reached their highest level in history (green dot above). This narrative plunged oil prices to their lowest levels on record.

However, as impressive as the selloff was, the rally off of the lows has been even more impressive. It's astonishing how quickly spread relationships across the market broke down and how quickly they recovered. As a result, many are left questioning week after week while inventories continue to build - do inventory levels even matter any more?? Perhaps the lack of chaos in the market is more stabilizing than one would have anticipated. Afterall, weekly inventory builds have leveled-off and we've even witnessed some weekly draws of Cushing inventories as space from the US SPR was leased out to commercial players and barrels were moved from Cushing (black line) to the US Gulf Coast (pink line).

The euphoria of a more 'stable' market may have caught people off-guard, but if history is any guide, it takes years to clear excess inventory from the market. For now, it appears as if inventory levels have taken a back seat as a driver in this market.


Production of everything energy-related is lower, although the 'processors' of energy (aka, the refiners) have reported increases over the last several weeks. We see that in the weekly product supplied figures from the EIA (gasoline on the left, jet fuel on the right).

Looking at US gasoline and distillate cracks, it appears the market (in gasoline at least) has been able to 'bear' this rebound in production and move higher.

There is such an interesting puzzle here. Is a crack spread market that encourages production an indication of real demand by end-users? If so, will refiner consumption of oil get ahead of oil production for a hot minute? Will this drive oil prices higher relative to product prices and put pressure on refining margins that leads to a false feedback loop? It's entirely possible, as there are many more places to hide oil than there are places to hide refined products.

Speaking of feedback loops, we don't need to look any further than oil production (blue line) vs oil prices (black line) below. There has definitely been what looks like a 'response' in oil prices to oil production declines in the US.

Does this mean that declines in oil production are the singular driver in the recovery of oil prices? Taken alone, that might be shaky ground to stand on considering that historically oil price rallies have been met with production increases. However, what IS 'different this time' is the belief that oil production may not respond in a timely fashion to price increases due to constraints in capital spending.

Refinery Demand

One might expect increased refining runs against a backdrop of declining US oil production to lead to a drop in US commercial oil inventories. However, this has not been the case. To get to the bottom of this, we look at the total crude supply available to refiners in the US (which is production plus net imports, green line below).

Historically, when refiner inputs (black line) have exceeded available supply (again, production plus net imports of crude oil) there is a decrease in oil inventories (blue line) and vice versa. This presents a more daunting picture because we now see that as refiner inputs increased, so did net imports and therefore, oil inventories continue to climb.

On a positive note, the increase in gasoline production (purple line below) has not led to new highs in gasoline inventories (blue line below). This means that there must be a modicum of actual gasoline demand to absorb the increased production. It has not, however, been enough to provide a meaningful reduction in inventory - the likes of which are normally seen during the summer driving months. To develop a bull case in the complex we would need to rely on the expectation that there will be a shift forward of the shape of the seasonal demand curve that collides with a lackluster increase in oil production.

Turning to a similar chart for distillates, the uptick in product supplied by refiners (green line) has led to exponential increases in inventory levels (black line). While it's normal for distillate inventories to build in the summer for use during the winter for heating, there is some concern that increases in refinery runs for gasoline output will further exacerbate distillate inventories.

What has eluded all markets at the moment is the ability to forecast what a recovery looks like. Equity market momentum driven by Federal Reserve action has spilled over to energy markets. Some take it to mean that a rally in equity prices equals a sure recovery in energy demand. And it's not difficult to imagine. While petroleum inventories are high, they have been at or near these levels before. However, the market HAS proven its ability to draw inventories down significantly (look at beginning of 2017 distillate inventories vs mid-2018 levels above). This does, however, require some sort of global demand growth.

Global Demand

Now that the US has joined the export market for oil, profitable spread margins are required to make those a lasting reality. At a high level, the spread between US Gulf Coast crude oil and Brent is a useful spread to gauge the health of export margins, to understand if there is a home globally for the incremental US barrel produced. It can also highlight the real-time logistical constraints that can plague physical markets. Often times, while it may appear there is an 'arb', that 'arb' window isn't real or isn't open long enough for someone to physically capture it.

Take the Brent/LLS continuous futures spreads below. The huge rally in early April should not be interpreted as a spike in global demand but rather an inability of anyone to capture the move logistically. What is more important is that absent the noise, this spread has been trending lower since 2018. Meaning that during a period of normal demand growth, growing US production available for export put pressure on export margins and therefore overall prices.

By 2018 the US had become a competitive player at $60 oil. At these levels, production was plentiful and spread margins made them a competitive supplier and led to US private investment in pipelines and export capacity. These investments are now levered-up in an environment that isn't friendly to leverage. At $60 oil it was reasonable to produce a barrel and get a $3 uplift (less transport costs) by shipping it overseas. Especially when the expectation at the time was that global spreads would continue to widen and would easily compensate for any capital investments. At sub $40 oil and a $1.50 Brent/LLS spread, the story is much different. With OPEC+ cuts in excess of 9 million barrels per day in place one might have expected this spread to widen-out. That has yet to happen. At the moment, global spreads are tight and awaiting a signal. For now, they are not a leader.


Sometimes the obvious underlying fundamental drivers cannot be used to explain strength or weakness in commodity markets. Often times there are larger macro forces that underpin price movements. Having reviewed several potential fundamental market drivers above and coming up relatively empty-handed regarding a leader, it's time to take a look at the less obvious yet relevant forces that affect oil prices (and all commodities at some level) that may be providing cover absent any other clear direction. The first being currencies.

Movements in the FX markets are often ignored by those seeking a fundamental reason to support oil price movements. However, at times they can be closely linked when looking at longer-term trends. Since oil is priced in US dollars globally and oil revenue is a significant portion of many countries GDP, there has always been a link between the two.

This link can be seen in hindsight in the chart above from roughly 2000-2009 where there was a clear inverse relationship between the two. Monetary policy across the globe since the financial crisis has muted this relationship to a degree, but it is still true that a lower dollar over time results in higher oil prices and a higher dollar over time results in lower oil price levels.

Certain currency pairs like the EUR vs USD have been highly correlated to price trends in crude oil.

With all of the central bank stimulus and relative currency value movements taking place as countries try to manage the fallout from the coronavirus pandemic, funds may be taking notice of disparities that have developed. Specifically, regardless of the fundamentals within the oil complex, oil may have just become too cheap on a relative basis to the US dollar.


Since the huge selloff in oil prices in April, money managers have been consistently getting net long WTI futures. Low prices have ushered in speculative interest that are betting on a significant move to the upside (blue line below). This has been a constant bid in the market since the swift decline in futures prices. However, last week was the first reported decline in money manager length as WTI neared the $40 level.

The correlation of open interest to prices is easy to see in hindsight, but not always a good indicator. But given the picture above we think it may be a factor as WTI prices contend with the $40 level.

Oil prices between $30-$40 are incredibly problematic if this becomes a long-term range. Everyone is looking for the influence that can move prices outside of this range. Charts across the board reveal conflicting trends. Choose your driver carefully.

Inventory Recap

Weekly Changes

The EIA reported a very slight total inventory DRAW (0.10)_million barrels for the week ending June 12, 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). Despite the build in total, crude oil posted another weekly build of 1.20 (excluding SPR).

Year-to-date, Total Inventories are relatively unchanged from last week with a BUILD of 165.80 million barrels. We continue to surpass all previous year-to-date builds by a long-shot.

Commercial Inventory levels (ex-SPR) compared to prior years for the same week ending in prior years are all at record highs except those at Cushing.


Lee Taylor - Technical Levels


Resistance: 43.41 / 45.98 / 48.40

Support: 39.90 / 36.40 / 32.91

The August Brent contract rallied back last week but still has major resistance above the market. On the weekly and continuation charts, we have a gap from 43.41 to 45.18 and on the August charts it is slighter wider between 43.41 to 45.98. As with WTI, we think the Brent market will retreat a bit prior to making another move to the upside – a move back down to 36.96 basis August Brent is likely in the cards. Aug/Sep Brent was able to break above resistance last week but will need to hold flat to +.03 to keep its upward track.


Resistance: 40.69 / 41.27 / 42.17

Support: 37.54 / 36.35 / 34.70

July WTI is coming off the board, so let us move onto August WTI. As we move over to August, we will notice that this contract will have a difficult time filling the gap. Prior to getting to the top of the gap (42.17), it needs to break through the 50% retracement (41.27) from its high of 62.12, to the low set in late April. To me, we may see a pull back to $36.35 before we get another big move to the upside. If Aug/Sep can hold -.09, we will see a move up to +.19, however, a retracement back to -.19 is more likely.


Resistance: 1.3029 / 1.3642 / 1.3840

Support: 1.2444 / 1.2331 / 1.1792

As we have discussed, the gasoline market seemed overbought based upon the RSI and appeared to have fixed that issue on its own earlier in the week. We find ourselves in that predicament once again. Flat price and RBOB spreads are extremely overbought and started to see some sell pressure late on Friday. We think that will continue early in the week and may last a bit – look for July/Sep to retest -95 and Sep/Oct to test 867.


Resistance: 1.2300 / 1.2538 / 1.2986

Support: 1.1824 / 1.16451 / 1.1159

July Heating Oil has been leading the energy complex over the last two weeks, but as I have been stating – it was completely oversold during the pandemic. July Heating Oil still made a huge push towards getting to the gap but failed at the 50% retracement level we mentioned last week. Any thought of filling the gap will need to wait until July settles above 1.2300. We have been bullish July/August and still maintain that outlook as it reached our objective of -166 and now look to -54 to flat.

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