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Oil Producer Report

Crude Oil Trading Report: Market has repriced – Collective amnesia in markets means the June/July sentiment “abyss” is now past

By September 15, 2017No Comments

Brent is 5% higher since the markets returned to action post the Labour Day break. As a result, the market has repriced any residual low sentiment from the June/July lows. The Brent forward curve has flipped into backwardation and a flurry of hedging activity has been processed through the market. Fundamentals are back in focus but algos have joined the buying.

For (commercial) producers, the recent price strength has important implications and offers good entry points to initiate (or add) to hedging portfolios, depending on the structure.

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CTC TRADING VIEW:

Sentiment has clearly shifted and we expect price pullbacks to be shallower than declines year-to-date. Our clients know our market views and the market is now pricing in a multitude of positives which we highlighted in past weeks:

1. Demand led recovery in oil prices and stock draws. IEA and OPEC monthly oil reports showed an upward revision to 2017 demand forecasts (SEE TABLE 1 – AVERAGE S/D OUTLOOK FROM IEA, OPEC and EIA – for more details).

2. Strength of refining margins. OECD product stocks were only 35 mbbls above the 5-year average at the end of July. Fallout from Hurricane Harvey could push product stocks below the 5-year average (refining margins above 5-year highs) which is ultimately positive for refinery throughputs and crude oil demand.

3. OPEC/NOPEC deal extension. The market has now priced in an OPEC deal extension for the full 1H 2018.

4. Extrapolation of non-OPEC production “beats” revised significantly lower this week. EIA revised US production lower, Q3 2017 -180kb/d, Q4 2017 -130 kb/d, 2018 -70 kb/d. E&Ps emphasizing capital discipline, while investors are pushing for improved returns at flat oil prices. These are big adjustments.

5. OPEC production. Nigeria producing (only) ~1.6 mb/d and Libyan barrels discounted to 1 mb/d due to instability suggests higher OPEC compliance into year-end.

6. Return of Chinese demand. China apparent oil demand up 6.3% in August. Nov/Dec cargo loadings healthy as refiners capitalise on strong margins.

7. Mexico annual producer hedge nears an end. The majority of the sovereign Mexico oil hedge appears to be behind us, potentially relieving a significant overhang on the market.

8. US producer hedging volumes and infrastructure issues. Hurricanes and US producer flows are capping WTI but other grades are less exposed. WTI-Brent arb and Brent structure highlight improved sentiment in global light sweet barrels.

9. Weaker USD and dovish Fed. The lack of US inflation and distinct lack of wage growth has the market complacent on the Fed’s ability to raise rates.

10. Greater geo-political risk. North Korea aside, the US is reviewing its policy on Iran that could include significant new non-nuclear sanctions when completed in October. Further, reported heavy tribal clashes in Iraq’s oil producing region with reported skirmishes close to West Qurna Phase 1, West Qurna Phase 2 and Majnoon fields. Shell relinquished the Majnoon field (230 kb/d) to the Iraqi government. Oil majors exiting is hardly positive for supply.

11. Flattening of the Brent curve has attracted capital flows rotating into commodities as an asset class. Yield, during this period of liquidity enhanced markets, is a long sought after commodity and a structural move into backwardation could have a meaningful impact on how the paper market trades.

Unquestionably, the market has discounted a lot of good news in very short order. Positioning and near term option strikes should be closely watched for a near term cap on prices (more on this below). Importantly, we continue to see “derivative dislocations” in the options market and producers must be attentive to structures and strikes as value varies greatly – CONTACT THE DESK FOR MORE ON THIS –

Chart 1 | DTD BRENT SWAP 18, 19 & 2020 | Source: ICE & CTC

Chart 1 | DTD BRENT SWAP 18, 19 & 2020 | Source: ICE & CTC

PRICE ACTION & POSITIONING:

FORMING A CAP: Positioning in WTI and Brent is long but not extreme. Refined products (gasoline, heating oil and gasoil) are another matter with the extreme bullish positioning representing the fallout from Hurricane Harvey and disruption to US refining infrastructure. Our concern near term, is that CTAs and algos have joined the buying and are exacerbating price momentum higher.

Our analysis points to further large additions to net length (will be reflected in next CFTC report) as all our short, medium and long-term trading signals, replicating CTA/trend following fund models, point to a “buy” signal (in crude).  This CTA/algo fund momentum has now been “ignited”. Some of our reliable sentiment indicators  point to signs of over-extended positioning (a counter cyclical indicator), similar to early summer levels where managed money was ironically positioned very short.

Options market positioning is now also a factor for near term price volatility with expiry for the Brent November 55C a little more than 1-week away and open interest at more than 9,000 lots. “Pin risk” could cap the market near-term.

Prices ran up to their technical targets this week, breached it and made new unsustainable highs. Stochastics are now clearly signalling “overbought” and are turning negative.

Key levels at this juncture: The year-to-date average of $52.30 bbl level, the Apr high of $56.65 and the year-to -date highs of $58.37 bbl. Based on near-term balanced risk/reward we recommend producers layer in hedges and look for further pullbacks or appreciation to optimize structures – CONTACT THE DESK FOR MORE ON THIS –

HEDGING FLOWS:

PRODUCERS: Mexico deal nears an end, shale producers remain active. News that Mexico’s sovereign oil hedge is nearing an end has significant implications for both oil market structure and options volatility.

Unequivocally, Mexico’s annual oil hedge is grounds for significant speculation and the significance of it nearing an end should not be overlooked. Implications are that it should provide some relief to back end crude oil selling (i.e. more attractive producer hedging levels). At the same time, put premium (versus calls), all important for producer hedges, could narrow and provide attractive opportunities.

Shale producers continue to lock in economics ahead of bank re-determinations and WTI CAL18 swap above $50. Our view on US shale is that oil prices will determine supply. Oil prices below $50 bbl means limits to shale oil production growth. Our view was validated this week with the EIA recently lowering its US production growth in 2017 and 2018.

However, oil prices in the $55 bbl range will echo a chorus of bearishness with potential for US shale to flood the market and challenge OPEC for market share. For perspective, a jump in the US rig count usually lags oil prices in the order of 4-5 months. So, while a jump in near term supply above expectations is unlikely, 1H 2018 remains another story, especially if prices move sustainably above the $50-54 bbl range for CAL18 WTI.

Shale E&P conference calls for 2Q 2017 where notably downbeat in August with CAL18 WTI floundering in the $46-48 bbl range. Capex cuts, lower producer forecast and drilling activity were the norm. Additionally, in the $46-48 bbl environment, E&Ps and Majors were emphasizing capital discipline, while investors were pushing for improved returns at flat oil prices. We suspect sentiment could change, for both companies and investors, if CAL18 WTI rears its head above $55 bbl.

Chart 2 | LATEST DATA (AVERAGE) | Source: IEA, EIA, OPEC & CTC

Chart 2 | LATEST DATA (AVERAGE) | Source: IEA, EIA, OPEC & CTC

CONSUMERS:

Refinery hedging is massive. With refinery margins at 5-year highs, the refining industry is heavily locking in margins. Activity levels bode well for crude demand as the refining industry take a role similar to that of the shale producer. However, rather than supplying the market with endless amounts of crude, the market will soon be faced with an insatiable demand for barrels, protected from market volatility with attractive hedging levels and economics. Global refined product demand is at 2-year highs, OECD inventory levels, which look to be soon below 5-year averages, provide ample room for refineries to ramp up throughputs significantly and at sustainably higher levels (with margins locked in).

SUMMARY VIEW:

Risk/reward is balanced at the moment, as the market comes to terms with a physical oil market which is tightening (everything from crude oil diffs, Middle East OSPs, refining margins, crude and refined product structure, inventory draws both onshore and floating, all point to bullishness), and economists spreadsheets, which highlight stock draws and price support through year-end but with concerns for an oversupplied market in 2018, particularly 1H 2018.

Contact CTC to know about more about how we help with risk-management, hedging related services and trading views: contact@comtradingcorp.com.

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Commodities Trading Corporation is a London-based private advisory company specialized in commodity risk-management and hedging. We service a growing need in the natural resources sector for unbiased and strong expertise and provide our services to an array of corporate clients and financial institutions. We are experts in derivatives and monetizing volatility and develop corporate strategies for hedging energy portfolios, using bespoke derivatives solutions for price risk mitigation.

For more information about what we do, how we can optimize your hedges and directly improve your bottom line, contact us at contact@comtradingcorp.com.

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