Oil price is $6+ bbl higher from recent lows in only a few trading sessions. The long positioning “washout” appears to be behind us and market perception is of a clear short-term bottom, combined with expectations of an extension of the OPEC/NOPEC deal. There are tailwinds ahead from the fundamentals picture which should feed into data.
Net buying is back from the “spec” community. The return of hedging volumes from US producers could remain a near term overhang with implications for the forward curve.
PRICE ACTION: The March 22nd intraday dip below $50 bbl was critical for short-term momentum and market psychology. The rejection of lower price acceleration, triggered the fierce price rally of ~$6+ bbl in only 12 trading sessions – See CHART 1 – The technical indicators, at the time, were pointing to an oversold market (as we pointed out), and are now tilting over the other side. Nonetheless, overall technical signals are for strength and momentum to persist.
Some of the stochastics are extended therefore it would not be surprising to see a short-term pullback and oil to trade towards its 100 and 50 day-moving-average (DMA) lines. We still view gasoline as the best leading indicator for crude oil flat price direction. Gasoline provided a strong signal for the recent move higher in crude oil prices. The chart highlights resistance/support on this move extremely well (which makes sense as the “washout” was sentiment driven).
POSITIONING: Monitoring the magnitude of change in managed money weekly data also proved a good indicator for calling a short-term bottom. Latest data shows that not only has the length (which was stopping out) halted but a combination of short covering and new length entered crude oil (1st increase in 5 weeks / roughly 10% increase) – See CHART 2 – Total oil USD notional managed money is around $41bn (+$6bn past week), which is about $49bn below the 5 year high of June 2014. Our analysis points towards the next CFTC data to show increased managed money buying in the front of the curve.
Chart 2 – Positioning – Source Goldman Sachs & CFTC
HEDGING FLOWS: The rise in flat price means Brent curve is now very flat – See CHART 3 – under $1 contango in the front and under $1 backwardation in Dec17/Dec18. For now, it appears only relatively muted US producer hedging is going through the market. The bigger US players seem to have not pulled the trigger just yet but that may be starting as we write. There is talk of hedging from non-US (watch fuel oil) at current levels (yet). Therefore, we are not (yet) seeing aggressive backend repression of the curve.
Chart 1 – Brent Price – Daily Since Dec16
Still, whatever hedging has gone through was enough to affect options volatility (i.e. producer hedge prices). The premium paid for the puts versus the equivalent calls, is now back towards the past year average (which is quite a big spread on a historical basis). This means for hedgers that buying outright puts it is, in relative terms, more expensive (…speak to us about optimising hedges).
While there is continued, consumer buying across the board, overall hedging flows are relatively muted. The main interest so far, is from hedge funds placing directional bullish trades, via out-of-the-money calls.
In summary, the chart “facts” show that oil prices in the very short-term appear slightly extended from main DMAs. Still, momentum is strong and current positioning, although certainly long, permits “dry powder” to push the front of the curve higher.
FUNDAMENTALS: The market has now fully priced in a rollover of the existing OPEC/NOPEC production agreement with Saudi Arabia officials leaking to the market an inclination towards a deal extension. The assumption is a rollover of existing terms (incl. Russia) for an additional 6 months. Like the FED uses forward guidance for its monetary policy, OPEC is using the same “template”, as the global inventory manager (as opposed to price target), using the 5yr average global stocks as a target.
We note that OPEC (Saudi) communication to the market is impressive in its timing and effectiveness. The paper/derivatives market has converged towards a calm, range trading oil price (ideal for Aramco IPO).
Even with recent geopolitical tension, the market expects the rollover and extension of the OPEC/NOPEC deal to go through. Increased adherence from Russia, as of last look its now above 2/3 of its production cut obligation (there was a lot of scepticism back in Dec), has only increased market confidence in extended agreement terms.
This time around, the consequences of production cuts should be much more visible in inventory draws as tailwinds from supply/demand side lie ahead.
First, visible global oil and refined products stocks for US/ARA/Sing/Japan, declined in February and March (-20 mil bbls) – See CHART 4. Further, less visible floating storage from Iran, sale of oil from Saldanha Bay storage terminals and the clearing of West African barrels at a faster rate than previous months all point to a clean-up of the storage overhang. The latest data shows that floating storage has ~halved since Dec16 (-50 mil bbls) – See CHART 5 –
Chart 3 – Brent Spreads
Second, geopolitical tension is increasing. Recent issues in Libya are unlikely to be resolved soon. Just as production returned to 700 kbd, El Sharara, producing 220 kbd, went down on Force Majeure combined with other issues at Wafa field (-40 kbd). Given the internal tension against the UN backed government in Tripoli, we don’t expect “conventional oil business” back soon. Obviously, this is constructive for light sweet, especially (seaborne) Dated Brent grade.
Third, global demand is strong, especially for refined products. This is in-line with expectations. Global PMIs suggest that hydrocarbon demand should continue to grow strong (JPM Global PMI Composite index is up ~5% from same time last year). Even in Europe, 1Q results from Repsol and OMV for example, point to a strong downstream and petchem market.
The strength in demand is strong across the board (gasoline, diesel, fuel oil) and as long as this translates into good ref margins, it will continue to be supportive for crude oil. The peak month for refinery maintenance is behind for the West and by end of May/June, there is expected to be some 5-mil refining capacity to return. This will increase demand for crude throughput and lower current oil stocks.
The US should show a similar pattern with respects to crude throughputs and crude oil stock draws.
However, this requires a bit of a leap of faith as for the moment, the US stock picture is not great to say the least – commercial oil stocks (incl. Cushing) at highest level ever last week. The counter to global light sweet oil disruptions is US production seen climbing as the US rig count climbs to 676 (+112% from May16 low), mostly driven by horizontal rig additions in the Permian basin.
Chart 4 – Global Oil & Refined Products Stocks, Source: Goldman Sachs
For now, the oil price has climbed back into the post-deal trading range. Our view is that flat price can still trade higher but the upside “explosiveness” potential is diminished. The point to watch is what happens to crude forward curve. OPEC does not want a repeat of last year’s contango. They sell OSP at spot, while commercial producers sell further out of the curve higher (via hedges). This point is important and will be in focus as a flip into backwardation, in the front would have a big impact on the market (and producers). Historically, once the curve flips, it tends to stay there for a while.
Probable scenarios: Deal Extension + improved fundamentals feeds into visible stock draws in coming weeks. Oil trades to post deal announcement highs, (was $58.37 in Brent and $55.24 in WTI). This resistance is eventually “taken out” as the front of the curve trades $2 – $3 higher. Dated Brent target $60 – $62.5, WTI target $57 – $60.
Let us look at CAL18 for comparison. CAL18 Brent was trading $57.3 bbl and CAL18 WTI $55.7 bbl post OPEC/NOPEC deal highs. The same magnitude of spread is unlikely to materialise; perhaps 1/3 of the move is the best one can expect. This of course is a function of the producer activity pressuring the backend, looking at the US rigs versus producer positioning, the correlation is pointing towards significant hedging above – see CHART 6.
To discuss further the implications and optimal hedging structures, contact us.
Chart 5 – Global Floating storage – Source Thomson Reuters
Chart 6 – US oil rigs VS US Producer hedging – Source: CFTC & EIA
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