TAC Market Talk

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Rally in Energy Markets Fed a Double-Dose of Reality

The rally in energy markets was fed a double-dose of reality this week as the IEA and OPEC both projected that global oil supplies are likely to outpace demand growth in 2018 after tightening substantially last year.  After 5 consecutive weeks of gains to cap off a rally dating back to June, petroleum prices were overdue for the correction it appears we are getting today.

The IEA released its monthly oil market report this morning, holding its demand estimates steady while projecting that the US, Canada and Brazil will lead production increases of nearly 1.7 million barrels this year, a full million barrels more than 2017.  The report also highlighted record global refinery run rates in the 4th quarter of 2017.

The other reality that seems to be sinking in hard with the oil bulls this morning is that, even with a record setting production decline from Venezuela (which  several analysts believe is being exaggerated for political reasons) OPEC’s total production still increased.  In some ways, Venezuela is actually making it easier for the rest of the cartel to not comply with the output cuts since its reported drop covers 25% of the total agreed reduction.

While the longer term outlook for global supply may be the big story this week, the US is still dealing with several short term refinery issues this week following the latest winter storm.  The rash of refinery issues – which numbered at least 9 yesterday – drove basis values from the Gulf Coast to the Midwest and NY Harbor to their highest levels since the fall.

The DOE report showed a 2% drop in refinery runs last week as US plants started what’s expected to be a very busy maintenance season, and it’s possible we could see some plants that were hit by weather this week move up their planned work to take advantage of the unexpected downtime.

Want to know why crude oil prices at their highest levels in nearly 3 year?  Yesterday’s DOE report may give the simplest reason, as US Oil inventories fell to their lowest level since February 2015.

After a 1-week drop, US Oil production bounced back sharply last week, putting domestic rates back on pace to surpass the 10 million barrel/day rate early this year.  Diesel demand set a new weekly record according to the DOE estimates in the wake of the record-setting cold snap to start the year.

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Charts from the DOE weekly report

Oil Prices Move Lower After OPEC Report

Oil prices were back on the climb higher overnight after the API reported another large weekly inventory decline, but have moved lower this morning after OPEC reported that the group’s output increased in December, in spite of the agreement to limit production.

The API continued the pattern of large crude draws and refined product builds for a 9th week.  The industry group was said to show total US crude oil inventories dropping by 5.1 million barrels, while the Cushing OK hub had a record drop of nearly 4 million barrels.  Gasoline stocks increased by nearly 1.8 million barrels, while distillates increased by 600,000.  The EIA’s weekly inventory report is due out at 10am central.

OPEC released their monthly oil market report this morning, showing a production increase in December as growth from Nigeria, Algeria and Angola offset further declines from Venezuela, Saudi Arabia and Qatar.  The report also summed up the recent oil rally quite succinctly, “…Both [WTI and Brent] futures contracts continue to be supported by growing indications that the oil market is heading smoothly toward rebalancing, lower crude oil stocks, healthy demand and geopolitical tensions.”

The report also noted the record amount of speculative funds betting on higher prices, and suggested that tighter monetary policies from the world’s largest central banks, “…is not likely to have a considerable impact on the oil market, particularly in an environment of improving economic growth.”

The winter storm that stretched from Houston to Boston yesterday caused a rash of production issues along the Gulf Coast refining hub.  At least 6 different power outages, flaring events or unit shutdowns were reported in Texas and Louisiana Wednesday morning as both states faced temperatures not seen in nearly a decade, helping Texas set an all-time record for winter electricity usage.  Those shutdowns and rate reductions sent RBOB prices surging to their highest levels since the aftermath of Hurricane Harvey.

The Midwest also had reports of various refinery issues, sparking a rally in Group 3 and Chicago basis values that outpaced the move in Gulf Coast spot markets.  The relatively small increases compared to other disruption spikes in basis differentials and calendar spreads suggests that so far the expectation is for these issues to have little impact now that warmer weather is on the way.

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Cracks in the Wall of the Energy Rally Beginning to Appear

A few cracks in the wall of the energy rally are beginning to appear this week as prices pull back from 3 year highs.  There are plenty of signs that we may have just set a short term top, but given the numerous head-fakes we’ve seen during this run – the longest oil rally in nearly 7 years –  it would certainly seem prudent to wait for further confirmation before declaring the end of the bull market.

Fundamentally it’s getting hard to justify crude in the high $60s as the OPEC cuts are already in place, and most projections show the US will lead a global increase in production this year, while global demand growth stays flat.  The EIA is predicting further production gains both on a per-rig and total basis in its latest monthly drilling productivity report released yesterday.  The agency’s weekly inventory report will be delayed a day due to the holiday, and we’ll get the API weekly stats tonight.  In addition, OPEC will release their monthly oil market report tomorrow and the IEA will release theirs on Friday.

From a technical perspective the stage is certainly set up well for a major pullback.  We’ve seen crude stall out right into the range of a 50% retracement of the 2014 price collapse, and are now seeing a shorter term break of the bullish trend lines that have held the rally for the past 5 weeks.

With stochastic and RSI indicators both in overbought territory – and record amounts of speculative money having already placed their bets on higher prices – there are plenty of reasons we could see a decline of at least 5% in the next couple of weeks, and perhaps much more as we enter refinery maintenance season.  Looking good on paper and actually happening are two very different things however, and as a coach famously put it, “That’s why we play the game”.

Shorter term the big questions this week will be how the winter storm sweeping across the country will affect both supply and demand.  Gulf Coast refineries – which aren’t built for cold weather – are facing an unusually long hard-freeze, but so far no shut downs have been reported.  Since temperatures are not expected to approach the lows we saw two weeks ago, it seems less likely that the insulated pipes at Midwest and East Coast plants are facing much of a threat, but we’ll have to see if this storm keeps drivers off the roads, or if it just increases heating demand.

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Energy Futures are Pulling Back to Start Tuesday

Energy futures are pulling back to start Tuesday, reversing course from Monday’s holiday-shortened session that saw several contracts hit fresh 3 year highs.  Brent crude settled above the $70 mark Monday (European markets weren’t closed) for the first time since December 2014, spurred on by a pair of issues in the MENA region.

More fighting in Libya forced the international airport to be closed Monday, stoking fears that the fragile government structure may not hold, and putting nearly 1 million barrels/day of oil output at risk.

Reports that fighter jets from Qatar had intercepted two commercial airliners from the UAE sent a few shockwaves through oil markets as it marked a clear escalation in tensions between Arab states that had been simmering on the back burner for several months.  Although the claims that the jets created any sort of danger are being disputed, it is a reminder of how much more sensitive the markets are to drama in the Middle East now when global inventories are closer to average levels than they were a year ago when inventories were close to record highs.

The weekly chart below shows that the rally in WTI has accelerated over the past few weeks, which in some ways puts more pressure on the bulls to keep up with an increasingly steep trend line.  If prices don’t hold above $63 this week, it appears likely that we’ll see a test of the $60 mark in the near future, and potentially as low as $57 without breaking the longer term trend.  With a busy refinery maintenance season on the schedule, and forecasts for increased US Production, the fundamental arguments for this rally to continue are beginning to dry up.

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Energy Futures Treading Water Just Below 3 Year Highs

Energy futures are treading water just below 3 year highs on a holiday-shortened trading session for NYMEX contracts.

It’s been 2 years since oil futures bottomed out at $26 for WTI and $27 for Brent, and the path has been essentially straight up for the past 7 months, leaving both contracts overdue for a correction lower.  That said, some of the most aggressive rallies in history have come from contracts that were already “overbought” such as the last time we saw a similar streak of monthly gains in 2011, when WTI went from $101 to $127 in the last 3 months of an 8 month run.

MLK Day is a Federal holiday so US Banks and stock markets are closed for the day.  Based on the global nature of energy contracts, not to mention the revenue concerns of the exchange, the CME group keeps trading open for an abbreviated session, although there will not be a settlement today and all activity will fall into Tuesday’s activity.  US Spot markets are not being assessed meaning most physical traders will take the day off.

10 more oil rigs were put to work last week according to Baker Hughes, the first increase in 5 weeks.  For the first several months of 2017 we saw an average weekly increase of 10 rigs before the count plateaued in the back half of the year.  A big question for 2018 is if drillers will continue to ramp up production with crude north of $60, or will they hold back to avoid another over-supplied market.

Money managers still love betting on higher energy prices as WTI, Brent and ULSD all reached all-time high net length for the speculative category of trader last week.  Oil producers also seem to like hedging at these levels as the Swap Dealer category also set a new record net-short position.  For the past 6 months the money managers have gotten the better part of that trade, even though the extreme positions for speculators are often known as a contrarian indicator.

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Oil Prices Pulling Back Following Reports of Sanctions Relief

Oil prices are pulling back from 3-year highs following reports that the US President would extend sanctions relief to Iran and that Chinese oil imports declined last month.  Brent crude broke the $70 mark briefly during Thursday’s session, WTI put a scare into $65 and ULSD came a few ticks away from $2.10 before the entire complex seemed to just run out of steam and stumbled into the close.

The action is very similar to what we saw a week ago with a Thursday peak and a Friday sell-off, so for those hoping for an end to the bull market, it’s probably a good idea to wait a few days before calling an end to the rally.

Depending on which headline you’re reading, the Chinese customs data could be both bearish and bullish for oil prices.  Some news agencies are focused on a counter-seasonal decline in imports of 9% for December, while others are noting that 2017 was a record year and that China surpassed the US as the world’s largest importer on an annual basis first time ever.   It’s worth mentioning that Chinese natural gas imports are also surging as the country tries to balance a growing economy and a severe smog problem, which could mean great news for US producers long term.

While the White House is leaving the Iran nuclear pact intact for now, expectations are that new sanctions outside of that agreement will be announced, in what appears to be some sort of compromise to avoid roiling allies without giving in completely to the agreement that has been the target of so much criticism.

While the daily correlation between energy and equity prices has been minimal for the past 18 months, the common theme of low volatility between both oil prices and US equities is clear and suggests an unprecedented lack of fear in both asset classes.  This may be another major theme for 2018 for those wondering just how much higher can either market go?

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March Higher Continues for Energy Prices as WTI and ULSD Set Fresh Highs

The march higher continues for energy prices as WTI and ULSD set fresh 3-year highs overnight and Brent is knocking on the door of $70/barrel.  The pending decision from the White House on Iranian sanctions continues to loom large over the market, making it seem easy for prices to continue along on their bullish trend lines for a 7th straight month.

Although the EIA’s weekly inventory report was less dramatic than the API, it did mark an 8th straight week of large crude oil declines and refined product gains, while demand estimates to start the year were good enough to keep the bull trend intact.

US Crude output dropped sharply last week, presumably due to complications from the extreme winter weather as most forecasts (including the EIA’s STEO) suggest that US production will average more than 10 million barrels/day this year.  A year ago Cushing OK inventories were close to capacity, but start 2018 below the 5-year average after 8 straight weeks of solid declines.  This could become a major story for the year if the NYMEX delivery hub stays relatively tight, and causes the WTI/Brent spread to close along with it, which could negatively influence refinery margins.

After setting a record for annual production in 2017, Refinery runs dipped across all 5 PADDs last week.  Total throughput rates are still several hundred thousand barrels/day above year-ago levels, and nearly 1 million barrels/day above the 5-year average for this time of year.  Refinery runs are expected to dip sharply over the coming weeks as plants catch up on maintenance that many postponed last fall in the wake of the hurricanes.

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WTI Reaches its Highest Level in 3 Years Overnight

WTI has reached its highest level in 3 years overnight, adding another dollar per barrel after punching through resistance at the May 2015 high of $62.58 during yesterday’s session.  The overnight high of $63.67 was aided by an 11 million barrel draw in US crude inventories that the API was said to report in its weekly report.

Refined products are somewhat reluctantly following crude higher this morning after a rash of refinery issues sent gasoline prices spiking to their highest levels since Hurricane Harvey in Tuesday’s session.  The API report had 4 million barrel builds in both gasoline and diesel inventories as refiners continued to ramp up production.

The butane pipeline leak near the Irving refinery in St. John New Brunswick was said to not cause any immediate issues at the refinery, but it could threaten production if the situation wasn’t resolved soon.

The EIA released its monthly Short Term Energy Outlook yesterday, predicting that Brent and WTI will average roughly $5-6/barrel less than where they’re currently trading for 2018 as global supplies increase after declining in 2017.  The report also noted that retail gasoline prices average 22 cents more now than they did this time last year, which sets up an interesting test for the year between the tax law just passed by congress vs. the fastest acting consumer tax for control of the American pocketbook.

Last week’s DOE report showed large declines in gasoline and diesel demand estimates in the last full week of 2017.  This week expectations are that we should see a spike in diesel demand as heating oil was called on to supplement supplies during the cold snap, while gasoline demand should continue its pattern of a dismal start to the year as drivers avoided the roads wherever possible.  The weekly report returns to its regular schedule today and is due out at 9:30 central.

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