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Oil Producer Report

Crude Oil Trading Report: Trend Exhaustion?

Geo-political headlines on Iran, Venezuela, and Middle East tensions pushed oil through $80/bbl. A new narrative focused on demand destruction, emerging market stress, Brent contango and rising interest rates is set to shift near term market sentiment.

A pullback at this stage is likely, with signs of trend exhaustion post max bullishness. Investment banks are now out-competing one another with $90-100/bbl price forecasts, short positioning is building and net length is selling into strength.

Restructure, restructure, restructure. Producers should look to restructure on a potential pullback. Consumers to add to hedges on weakness.

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EMOTIONS RUN DRY

We’ve had the emotional headlines related to Iran, Venezuela and Middle East tensions and the subsequent push through $80/bbl.

Since the 15th May, Brent is trading in and out of $80/bbl. Note that this is the case intraday and that we have NOT had any market close (official exchange print) at or above $80 bbl so far. Obviously, we are a stone throw away but nonetheless sentiment is not managing more for now.

Our $80/bbl target (see previous report) is proving a short-term resistance. We have yet to see if $80 bbl is a medium-term pivot as we have called for weeks ago.

We’ll need a catalyst now to take Brent higher (Trump could well be that of course) but note that we did not break higher on a multitude of very bullish news: the Houthi missile Monday, the force majeure on bonny light, the Pompeo Iran rhetoric “sanctions as never seen before..” and the Venezuela oil capabilities accelerating into the abyss with the latest sanctions on any US person holding Venezuelan debt.

Despite the headline risk, physical oil disruptions remain months away and by all means market memories are short.

Technicals point to momentum and trend exhaustion, while front-end timespreads highlight a disconnect between the paper and physical markets with Brent and WTI curves in contango. This is not a sign of a fundamentally tight oil market. Fundamentals may catch up to the bullish paper market but it will take time.
With the market now grasping and clawing for direction, the time is ripe for a change in the narrative. We see it unfolding something like this:

 

 

• Short memories: “Lost” Iran barrels are months away. In the meantime, a flood of short term supply should emerge pre-sanction deadlines.

On Venezuela, “the street” has factored in production falling to 1.1-1.2mb/d before year end. Furthermore, the Conoco suit has Venezuela scrambling to sell additional oil ahead of more potential seizures from creditors. Refining utilizations below 30% suggest that all available Venezuela crude will be exported.

As supply disruption risks move from front to back page news, it could be a trigger for fast money to liquidate near record long positions.

• Demand destruction $80/bbl: On an absolute basis the global economy can handle $80/bbl. However, a 75% increase in oil prices since June 2017, virtually in a straight line, poses potential problems for emerging market countries including Turkey, South Africa, India, SE Asia and Argentina.

To add, demand has likely been brought forward as a result of Iran sanctions and rising geo-political risks, exaggerating crude oil demand growth for the first 5-months of the year.

Furthermore, the US driving season is set to start with the prospect of $3/gal gasoline prices. It’s not hard to envision a slowdown in oil demand growth for 2H 2018.

• Brent contango: Wait a second, contango doesn’t sound right in a tight oil market and we don’t think this will go unnoticed by the market, especially if the risk of supply disruptions fade from the headlines.

Consumer buying, rising US exports, refinery maintenance and surge supply from Iran and Venezuela help explain some of the weakness but spreads will have to reconnect with oil prices if upward price momentum is to continue.

BRENT | De-correlation with spreads | Consumers stepping in the back end

BRENT | De-correlation with spreads | Consumers stepping in the back end

• Rising US exports: US exports are expected to move from 1.5-2.0mb/d to 2.0-2.5mb/d in the 2H 2018. Europe imports of US crude hit an all-time high last week and have been a key driver of Brent contango.

Brent-WTI, Permian differentials widening should provide significant incentive to expand US export infrastructure. This will take time but shale could once again emerge as OPEC’s Achilles heel if US export infrastructure is incentivised to expand at a faster rate than currently estimated.

• OPEC meeting uncertainty: Russia Energy Minister, Alexander Novak, has already started to manage the market lower with a change in rhetoric, now focusing on demand destruction with oil at $80/bbl. Iran sanctions and falling Venezuela production, in light of global inventories falling below the 5-year average goal, should also prompt discussion and speculation on dismantling the OPEC+ production cut agreement.

While OPEC will mostly likely kick the can further down the road to the December OPEC meeting, the debate could spark volatility and uncertainty in the near term.

• Market flows: Consumers are hedging, which is supporting the back end of the Brent. Traditionally, consumers have been late cycle buyers.

Producer flow has been highlighted by the start of the large sovereign hedge. While consumer buying may absorb some of the sovereign hedge volumes, record net length poses the question on how the market can absorb the selling which many see as an opportune moment to take some chips off the table.

Moreover, the “sticky” index money attracted to the roll yield now has to compete with a shrinking roll yield and a 10-year US Treasury yield >3.1%.

Consensus Supply/Demand Forecast

Consensus Supply/Demand Forecast

WE ARE NOT BEARISH ON FUNDAMENTALS
We are not complacent on the longer term risks associated with a narrowing inventory cushion and falling OPEC spare capacity during a period of growing geo-political risk and supply disruption. Our view is that memories are short and without a near term supply issue the market will start to look for a new narrative, one likely to fit price action, not the other way around.

In other words, if we get some near term profit taking, an acceleration in the execution of the sovereign hedge and a pull back in oil prices; headlines would follow suit on that change in sentiment. We remain structurally bullish, but the time is ripe for near term profit taking.

RESTRUCTURE, RESTRUCTURE, RESTRUCTURE
For producers, a temporary pullback would provide an opportune moment to restructure collars and swaps.

Meanwhile, consumer buying in the back end of the curve could provide and the optimal moment to layer in longer dated structures as the curve flattens.

To discuss further the implications and optimal hedging structures, contact us – contact@comtradingcorp.com

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