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Oil Producer Report

Crude Oil Trading Report: OPEC/SAUDI got what they wanted: backwardation – Brent positioning extreme but largest clips sitting in-the-money

By September 27, 2017No Comments

All the excitement in oil is focused and positioned on the very front of the curve. The result has been a phenomenal, multi-year record move in timespreads.

In a classic case of market trading psychology at its best, the “collective amnesia” concerning fears present only a few weeks ago has now turned into consensus bulls. We believe the time to be screaming bullish was in June/July (as our clients and readers of this report know). With product markets tight in the Atlantic, the picture for Brent is constructive – certain signals we monitor point to a situation that has done too much, too fast.

We look at “what now” and – what are the signals to monitor for another inflection point:

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CTC TRADING VIEW:

Just what OPEC wanted – a V-shaped crude oil recovery: We are not referring to the speed of the oil price recovery (3-years can hardly be regarded as V shaped) but rather to the uneven shift in the Brent curve with the front dramatically outperforming the back end of the curve. Brent timespreads have had a multi-year record rally, particularly from the sell-off in late June – SEE CHART 1 –

With this latest move, OPEC/ Saudi Arabia appears to have succeeded in engineering a backwardated Brent market, sending signals that the market is in transition and near the end of the “lower for longer era”, characteristic of the past 3-years.

As we highlighted over the weeks, a combination of positive fundamentals are now aligned in Brent and now largely factored in:
• Demand led recovery in both OECD and China
• China SPR stock builds
• Faster than estimated stock draws, primarily in refined products
• Refining margin strength
• Potential of an OPEC/NOPEC deal extension
• Changing sentiment towards US shale supply growth
• Rising geo-political risk with North Korea, Kurdistan and Iran
• Brent backwardation attracting investor capital flows

However, the move in the back end of the oil curve has remained stubbornly subdued, leaving producers frustrated by the lack of participation in recent Brent strength.

For perspective, from the late-June lows, front month Brent is up 30%, while CAL18 and CAL19 are up between 10-17%. The frustration is self-inflicted obviously as the reason for the lack of movement in the longer dated prices is that producers in both Brent and WTI are out in full force and these flows are capping rallies in the back end of the curve.

The combination of strong oil prices and emboldened US producer hedging would typically bring the market reeling on concerns of a potential flood of US shale volumes into the market. However, US producers are going through somewhat of an identity crisis with investors rewarding return on/of capital over growth. Case and point is the recent $2.5 bln announced share buyback from Anadarko where investors rewarded the announcement with ~9% share price appreciation.

The elasticity in US shale means hedging will push producers to raise volumes (certainly the market perception will) after a period where the breaks were put on drilling in recent weeks.
However, CAL18 WTI at $52 /bbl has cooled investor sentiment for US shale growth for now. Equity flows have for weeks now rewarded prudent US shale producers, containing rising cost structures (with WTI below $55/bbl).

Nevertheless, the market will expect US shale production to show robust YoY growth and with Brent trading at a $6+/bbl premium to WTI, we expect US crude exports to ramp up materially in the coming weeks. This should be watched closely for a turning point in Brent (relative to other grades).
Importantly, we now see important “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 –

POSITIONING, WHERE DO WE GO FROM HERE: POSITIVES & RED FLAGS
Price makes the news and not the other way around. Only a few weeks ago, the market was positioned very short and headlines were angled negatively (especially from sell-side research). This is where markets are fascinating and why we focus so much energy in analysing sentiment: CTA/fund positioning across the oil complex is at multi-year highs and almost all headlines are now entirely bull stories – we note, with the most vocal bears now aggressive bulls.

CHART 1 | BRENT DEC/DEC SPREAD IN % CHG | HISTORICALLY JAN-DEC | SOURCE: ICE & CTC

CHART 1 | BRENT DEC/DEC SPREAD IN % CHG | HISTORICALLY JAN-DEC | SOURCE: ICE & CTC

Currently, several (but not all) of our signals we monitor are flashing “red”, mostly from Brent and refined product length which point to warning signs:

• Brent net length of 695 mbbls, near all-time record highs of Feb 2017
• Gasoil net length set a new record high of 17.2 mln tonnes
• Heating oil net length @ 51 mbbls, highest since Feb 2013 highs
• Gasoline net length @ 71 mbbls, highest since April 2014 highs
• Ratio of long to short positions near multi-year highs for gasoil, heating oil and gasoline

Our analysis suggests that most of the significant long investor clips were initiated in Brent within the $55-55.85/bbl range. This is important to note as well as the effect on trading psychology.

At the moment, Brent longs are in-the-money by a decent margin, therefore we cannot expect the “washout”, “first to blink” cascading mentality typical at trend exhaustion.

Positioning is not always this way and therefore any near term pullback could result in resetting stretched chart technicals – creating a sort of breathing space for a further push higher – CONTACT THE DESK FROM MORE ON THIS –

Near term , with refining margins as strong as they are, it is constructive for Brent. Demand and seasonal Q4 stock draws in the order of 25 mbbls, make it very difficult to be negative on the fundamentals side. The issue at this juncture is that this tightness is now largely factored into the price. Oil futures are now taking on a more equity-like trading feel, reflecting the dominance of paper market and especially investor flows.

CHART 2 | PRODUCER HEDGING TARGET LEVELS | SOURCE: ICE, BBG & CTC

CHART 2 | PRODUCER HEDGING TARGET LEVELS | SOURCE: ICE, BBG & CTC

The main signal to monitor now is distillate and should be viewed as the “leading indicator” for Brent price and spreads direction and for signs of trend exhaustion.

How long can this bullish sentiment last?

The key date, in our opinion, is the 30 November OPEC meeting. The combination of bullish fundamentals, rising geopolitical risks (Venezuela, Kurdistan, Iran and North Korea) and positive roll yield from backwardation, which increases the attractiveness of money flows into crude indexes, make this a very realistic outcome.

The picture for 2018 is unclear and as prices rise the market’s sentiment and focus can quickly shift to 1H 2018. As a reminder, S/D balances and consensus IEA, EIA and OPEC forecasts point to an oversupplied market in the order of 0.5-0.6mb/d for 1H 2018. Until the November OPEC meeting, traders will look to a couple of key data points for increased visibility, namely:

1) US shale production: Q3 earnings from late-Oct through November for better insight into potential 2018 production growth forecasts, and

2) renewal of Iran sanction waivers on October 15. This raises the potential for another meaningful sentiment shift in the oil market.

In addition, the market will start to look at seasonal 1Q refinery maintenance and how the impacts of Hurricane Harvey could translate into potentially higher Atlantic Basin turnarounds as scheduled fall maintenance was postponed due to record high refining margins.

This impact could be reflected in both lower crude oil demand (lower refinery throughput) and higher US crude oil exports. As it stands, this more negative picture for early 2018 is a growing possibility.

SUMMARY VIEW:

Market tightness is progressing in a logical pattern (Asia first, uneconomic floating storage taken out, EU main storage hubs and the last to draw US inventories). It is also “healthy” as the demand pull has been global and most importantly across the barrel (not concentrated on one product, with less “switch” incentives).

We are not shy to share our strong views but at this juncture we believe it has now become much harder to call the next $2-3 bbl move (substantiated on concrete points). We view that June/July was the time to be a contrarian and constructive on Brent price and structure (as our clients know we were clearly). Now, the bulk of the move has been realised.

The key date ahead to target is the Nov 30th OPEC meeting, until then gasoil must be monitored as the “leading indicator” for Brent direction.
Physical oil market are tighter (from crude oil diffs, Middle East OSPs, refining margins, crude and refined product structure, global inventory draws both onshore and floating). This is undeniable, but the issue is now on the extended positioning (although sentiment can keep it going).
Counterintuitively, current higher prices, may be setting up the market for a pullback in early 2018.

Lastly, we must keep in mind that historically at least, a shift to deep backwardated curve, such as the move now in Brent, means it is here to stay. With the adjustments and importance it brings along for (commercial) oil producers.

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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CTC Marketing Commentary Disclaimer – This marketing communication has been prepared by CTC traders and sales personnel. The information contained within this marketing communication is general market commentary providing only the views an opinions of CTC traders and sales team. The views and opinions expressed herein may be changed at any time without notice. This material provides only a limited view of the market and does not constitute investment advice and or investment research. It has not been prepared with the legal requirements to promote the independence of investment research. It is also not subject to any prohibition on dealing ahead of the dissemination of any investment research. The information provided does not constitute an inducement, invitation or offer to engage in any investment activity. CTC neither makes nor gives any representation or warranty, express or implied as to the accuracy or completeness of the information and opinions contained and no responsibility or liability is accepted by CTC for the same and CTC shall not be liable for any direct, indirect or consequential loss or damage suffered or incurred by any person upon reliance of any statement or opinion or other such information. This communication is directed at CTC‘s professional customers and not intended for retail or private customers.