Welcome to the split market edition of Oil Markets Daily!
The oil market is never straightforward, and given the diverging fundamental dynamics today, the global oil market is torn between two realities – undersupplied crude market and oversupplied product market.
Products have been under a lot of pressure as of late due to low heating demand around the world. We’ve had one of the warmest starts to winter for the Northern Hemisphere since 2006. Europe and the US have barely registered a boost in HDDs, so this is sapping heating demand globally.
In addition, with crude differentials still trading near the highs, refinery margins have been obliterated.
If you are a refinery unable to source cheap feedstock, forced refinery run cuts may be your only option. The crude market is then starting to price in some of this potential run cuts into the flat price. As markets go, if the buyers start to wane, then prices would have to drop, right?
Well, not necessarily, Saudi’s crude exports have stayed low for the last two months now. For January, volumes are likely to be ~6.3 mb/d or similar to December. Preliminary February volumes suggest the same export levels again.
This would leave the world in a rather precarious place. Refineries are going to cut throughput, but what if crude spreads remain high? What will follow then is quite simple – the forced run cuts would have to drain enough out of the product storage.
We should also see this firsthand in the US. Refinery throughput by next week is expected to drop to ~15.9 mb/d with February averaging around ~16.1 mb/d according to our low model. If so, then product inventories should continue to draw. But even with such a low refinery throughput figure, the low inbounding imports and elevated exports are likely going to keep crude storage trending lower.
Source: EIA, HFI Research
This combined with the data that US oil production is seriously rolling over leads us to believe that the solution to this market is just – forced run cut leading to lower products, while crude remains tight.
Source: EIA, HFI Research
The implication of lower US oil production volume will have another side effect going forward. The unaccounted-for crude oil is likely to trend flat to negative as EIA currently estimates ~13 mb/d for US oil production. This leaves a gap of about ~400k b/d. Even if we assume all of the ~400k b/d is related to unaccounted for NGLs being stuffed into production, then we should still see the adjustment trend towards zero.
At least according to our historical data, we see the adjustment likely explaining ~400k b/d of the unexplainable delta.
All-in-all, the market is contending the oversupply in the product while the crude side is undersupplied.
Forced run cuts are coming and this will help alleviate the issues on the product side. But with the market now fixated on the coronavirus breakout in China, sentiment will dominate trading in the short term before steady heads prevail again.
Our take is that given the crude tightness we see, prices should be somewhat supported here. We have initiated a long UWT position with a tight stop.
Source: HFIR Oil Trading Portfolio
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Disclosure: I am/we are long UWT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.