“For now at least, it has become hard to risk capital on the price of oil with as much conviction as in the past.”—Andy Hall, famed oil trader, on shuttering his oil hedge fund.
If Andy Hall is confused, what does that say about the rest of us? This checklist tries to identify some of the anomalies in the global crude oil marketplace which presumably will ultimately get resolved even if they don’t seem to have any resolution at the moment. So here’s an oil watcher’s late August list of things to keep an eye on:
Brent versus WTI spread
At well over $4 and change, why is the Brent versus WTI spread so large, the largest since early 2015? Is it increased European and Asian demand as a result of more robust economic growth or weaker US demand and higher US production—or a combination or more precisely what combination of both?
From contango to backwardation
The October Brent futures contract is now in backwardation, while the corresponding WTI contract has seen its contango narrow significantly to just pennies per contract. In 2016, when WTI was trading around the same $47-48 level, the contango (note: not the spread) was as much as $4. Backwardation and/or a diminished contango imply quicker inventory depletion and consequently higher commodity prices. But in the present circumstances, what gives?
During the process described above, prices for WTI and Brent were actually falling while the Brent contract’s backwardation increased and the WTI contango narrowed. Changes to the term structure are generally regarded as the best future determinant of crude oil prices. What does this disparity tell us?
Despite continued, significant weekly draws, crude oil inventory levels are still robustly high. While drawdowns have taken inventory levels well below 500 million barrels for the first time in months,YTD, crude oil inventories are down cumulatively just under 30 million barrels; interestingly, gasoline (down just under three million barrels) and distillates (down just under five million barrels) are barely negative (EIA data: This Week in Petroleum.) So should inventory levels prove to be more impactful on crude prices in 2017 than they were in 2016? Or is pricing still really just a function of the weakening US dollar, which is down by about 8% during this period?
Demand focuses on the paradox of declining Chinese and US demand and growing US production. On the latter front, yet another increase in US production last week amounted to 79,000 barrels per day according to the EIA. On the former, a Reuters story from earlier in the summer (China, India, Japan hamper Asia oil demand growth, efforts to balance market) quotes Michael Corley, managing director of Mercatus Energy Advisors: “We are indeed seeing lower demand from more than a few clients – air, marine, road, industrial … They are actually consuming less fuel than anticipated.” The three countries together account for about 20% of global demand.
Has the world forgotten about OPEC? Reduced but nonetheless consistently robust production from OPEC at just under 35 million barrels per day along with falling compliance (currently reported at around 75%) puts the recent St Petersburg agreement in the spotlight and probably spells trouble. Does anybody have much faith in OPEC in any case?
Trader interest in crude as measured by the weekly Commitments of Traders reports from the U.S. CTFC is in a declining trendline with the exception of the recent upward blip in trading activity (see chart.) The technical picture, however, continues to deteriorate even as crude has experienced a number of counter-trend rallies.
Anomalies exist. And if one of the world’s greatest energy traders is calling it quits, it’s clearly time for caution (for more see: Are Oil Markets Becoming Untradeable?)
WTI Commitments of Traders 2016-2017
COT Net Positions
The technical picture of futures trading activity resembles the technical profile of WTI itself—a series of lower highs and lower lows.
This article was originally published on Oilprice.com.
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