Analys
Crude oil comment – The dissconnect and the reconnect
Brent crude sold off 4.7% ydy to a close of $48.38/b (1 mth contract) while in the longer dated contracts we saw the December 2020 contract lose 2.1% to trade down to $51.15/b which was the lowest level since April 2016. Early this morning the Dec 2020 contract traded as low as $50.5/b. At the time of writing the 1 mth Brent contract is up 0.5% to $48.6/b after having traded as low as $46.64/b in the early hours of the day.
The discussion is going left, right and centre for explanations of why we have such a sharp sell-off in commodities in general and oil specifically. Is the macro backdrop deteriorating? The decline in US consumer confidence by 5 points from March to April as well as a topping over of the global manufacturing PMI at the same time might have been a queue to macro driven investors to take profits on commodities in general. The general view is however that the macro backdrop is fine. That US Q1 growth weakness is transitory and that Chinese infrastructure contractor order intake was strong in Q1-17. Chinese tightening liquidity settings aiming to prevent overheating and too much speculative activity is probably a part of the reason for the sell-off in metals. As such it seems like there is a disconnect between the general macro-view which looks overall positive and the current commodity sell-off which is blood red. Graphing global PMI to commodities does however paint a picture of a fairly good relationship. Is the commodity sell-off an indicator that the somewhat rosy macro view is wrong? Probably not seems to be the main view so far.
Another angel for the sell-off in crude oil is US gasoline. Looking at the sell-off in crude oil we can see that the sell-off has been preceded by a sell-off in gasoline. Gasoline and the driving season is normally a bullish element this time of year. Counter to normal we have instead had a sell-off in gasoline which has been feeding into a bearish pressure on crude oil as well. So weakening US gasoline prices clearly are partly to blame for the latest crude sell-off.
Rapidly rising US crude oil production in combination with elevated net long speculative positions in WTI has of course been important foundation for the current sell-off. Speculators have been taking cover as the price moved into technically bearish territory. On Tuesday next week the US EIA will publish its last monthly energy report before OPEC’s meeting on May 25th. It is likely to lift its projected US crude oil production for 2018 yet another 150 – 200 kb/d as it accounts for the 35 oil rigs which were added to the market in April.
Hardly anyone seems to doubt that OPEC will roll over its cuts from H1 to H2 and Russia also seems to be positive for such a decision. This is probably the biggest disconnect in the oil sell-off. OPEC seems positive for cuts, Russia seems positive and the general market expectation is for a roll-over of cuts into H2. A decision to roll over cuts into H2-17 when OPEC meets on May 25th in Vienna will clearly lift Brent crude oil prices back up towards $55/b. As such the current sell-off to $46-47-48/b is clearly a disconnect to the consensus that OPEC will cut in H2-17. Cutting in H2-17 will however stimulate more US oil rigs to enter the market thus leading to higher production in 2018 and 2019. As such a decision to cut on May 25th will be a sacrifice of the balance and oil prices for 2018 and 2019 as it will shift both of those years into strict surplus.
But for now the sell-off is a disconnect to the view that OPEC will cut. As such it is a good buy ahead of the OPEC meeting which is now less than three weeks ahead. Unless of course OPEC totally caves in and instead lets oil production flow unhindered. That would be a vindication of prior Saudi oil minister Ali al-Naimi’s earlier aired view that cutting production is not a good idea as it would only lead to lower volume but not necessarily a higher price. Saudi Arabia may however have too much at stake with its planned Saudi Aramco IPO planned for early 2018 to let the oil flow loose quite yet. Thus betting on the consensus for a cut and buying the current sell-off may not be such a bad idea and strattegy. Rather we think it is a good strattegy to buy into the current sell-off at the moment ahead of the upcoming OPEC meeting.
On the one hand there is now a dissconnect between a strong belief in an OPEC cut versus a current weak oil prices. On the other hand though one might also say that the oil price finally has reconnected with shale oil fundamentals. If the oil market is in no need for yet more oil in 2018 then there is no need to activate yet more oil rigs in the US right now. At the moment we forecast 2018 to be close to balanced. As such the mid-term WTI crude price curve should traded at about $47/b (empirical rig count inflection point versus prices). The 1-2 year WTI forward curve at the time of writing trades at $47.8/b. But that reconnect looks likely to be foreced apart again if/when OPEC decides to roll cuts over into H2-17. In that case the reconnect is postponed to 2018. Post the Saudi Aramco IPO.
Ch1: Global growth momentum topping out?
Graphically yes, but general view is that global growth is fine and that US Q1-17 weakness is transitory
Ch2: Commodity prices are softening anyhow
Ch3: Gasoline prices usually a bullish factor into the US driving seasson – But this time it has been a bearish factor dragging crude prices lower
Ch4: Relationship between US mid-term WTI forward prices and weekly US oil rig additions
The inflection point is from April/May/June last year
Kind regards
Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking
Market is starting to take US/Iran headlines with a pinch of salt. Brent crude rose $2.8/b yesterday to an official close of $112.1/b. But after that it traded as low as $108.05/b before ending late night at around $109.7/b. Through the day it traded in a range of $106.87 – 112.72/b amid a flurry of news or rumors from Iran and the US. ”US temporary sanctions during negotiations” (falls alarm). ”We will bomb Iran” (not anyhow),… etc. While the market is still fluctuating to this kind of news flow, it is starting to take such headlines with a pinch of salt.
We’ll see. Maybe, maybe not. The Brent M1 contract is trading at $110.2/b this morning which very close to the average ticks through yesterday of $110.4/b.
Trump with bearish, verbal intervention whenever Brent trades above $110/b it seems. What seems to be a pattern is that Trump states something like ”very good negotiations going on with Iran”, ”New leaders in Iran are great,..”, ”Great progress in negotiations,…”, ”Deal in sight,..” etc whenever the Brent M1 contract trades above $110/b. An effort to cool the market. These hot air verbal interventions from Trump used to have a heavy bearish impact on prices, but they now seems to have less and less effect unless they are backed by reality.
As far as we can see there has been no real progress in the negotiations between the US and Iran with both sides still standing by their previous demands.
Iran is getting stronger while the cease fire lasts making a return to war for Trump yet harder. Iran is naturally in constant preparation for a return to war given Trump’s steady threats of bombing Iran again. Iran is naturally doing what ever is possible to prepare for a return to war. And every day the cease fire lasts it is better prepared. This naturally makes it more and more difficult and dangerous for the US to return to warring activity versus Iran as the consequences for energy infrastructure in the Persian Gulf will be more and more severe the longer the cease fire lasts. Israel seems to see it this way as well. That the war is not won and that current frozen state of a cease fire gives Iran opportunity to rebuild military and politically.
Global inventories are drawing down day by day. How much? In the meantime the Strait of Hormuz stays closed. There is varying measures and estimates of how much global inventories are drawing down. Our rough estimate, back of the envelope, is that global inventories are drawing down by at least some 10 mb/d or about 300 mb/d in a balance between loss of supply versus demand destruction. Other estimates we see are a monthly draw of 250-270 mb/d. The IEA only ’measured’ a draw in global observable stocks of 117 mb in April with oil on water rising 53 mb while on shore stocks fell 170 mb. But global stocks are hard to measure with large invisible, unmeasured stocks. As such a back of the envelope approach may be better.
Oil products is what the world is consuming. Oil product prices likely to rise while product stocks fall. Strategic Petroleum Reserves (SPR) are predominantly crude oil. Discharging oil from OECD SPR stocks, a sharp reduction in Chinese crude imports and a reduction in global refinery throughput of 6-7 mb/d has helped to keep crude oil markets satisfactorily supplied. But global inventories are drawing down none the less. And oil products is really what the world is consuming. So if global refinery throughput stays subdued, then demand will eventually have to match the supply of oil products. The likely path forward this summer is a steady draw down in jet fuel, diesel and gasoline. Higher prices for these. Then, if possible, higher refinery throughput and higher usage of crude in response to very profitable refinery margins. And lastly sharper draw in crude stocks and higher prices for these. But some 6 mb/d of oil products used to be exported through the Strait of Hormuz. And it may not be so easy to ramp up refinery activity across the world to compensate. Especially as Ukraine continues to damage Russian refineries as well as Russian crude production and export facilities.
Watch oil product stocks and prices as well as Brent calendar 2027. What to watch for this summer is thus oil product inventories falling and oil product premiums to crude rising. Another measure to watch is the Brent crude 2027 contract as it rises steadily day by day as the Strait of Hormuz stays closed and global oil inventories decline. The latter is close to the highest level since the start of the war and keeps rising.
The Brent M1 contract and the Brent 2027 prices and current price of jet fuel in Europe (ARA). All in USD/b
Our back of the envelope calculation of the global shortage created by the closure of the Strait of Hormuz. Note that 3.5 mb/d of discharge from SPR is also a draw. Note also that ’Forced demand loss’ of 2.5 mb/d is probably temporary and will fall back towards zero as logistics are sorted out leaving ’Price demand loss’ to do the job of balancing the market. Thus a shortfall of at least 9 mb/d created by the closure. More if SPR discharge is included and more if Forced demand loss recedes.
Brent is climbing higher. Front-month is at USD 106.3/bl this morning, close to a weekly high and a USD 9/bl jump from Mondays open. This is the move we flagged as a risk earlier in the week: the market shifting from ”a deal is around the corner” to ”this is going to take longer than we thought”.
Analyst Commodities, SEB
During April, rest-of-year Brent remained remarkably stable around USD 90/bl. A stability which rested on one single assumption: the SoH reopens around 1 May. That assumption is now slowly falling apart.
As we highlighted yesterday: every week of delay beyond 1 May adds (theoretically) ish USD 5/bl to the rest-of-year average, as global inventories draw 100 million barrels per week. i.e., a mid-May reopening implies rest-of-year Brent closer to USD 100/bl, and anything pushing into June or July takes us meaningfully higher.
What’s changed in the last 48 hours:
#1: The US military has formally warned that clearing suspected sea mines from SoH could take up to six months. That is a completely different timescale from what the financial market is pricing. Even a political deal tomorrow does not immediately reopen the strait.
#2: Trump has shifted his tone from urgency to ”strategic patience”. In yesterday’s press conference: ”Don’t rush me… I want a great deal.” The market is reading this as a president no longer feeling pressured by timelines, with the naval blockade running in the background.
#3: So far, the military activity is escalating, not de-escalating. Axios reports Iran is laying more mines in SoH. The US 3rd carrier strike group (USS George H.W. Bush) is arriving with two countermine vessels. Trump yesterday ordered the US Navy to destroy any Iranian boats caught laying mines. While CNN reports that the Pentagon is actively drawing up plans to strike Iranian SoH capabilities and individual Iranian military leaders if the ceasefire collapses. i.e., NOT a attitude consistent with an imminent deal!
Spot crude and product prices eased off the early-April highs on a combination of system rerouting and deal optimism. Both now weakening. Goldman estimates April Gulf output is reduced by 14.5 mbl/d, or 57% of pre-war supply, a number that keeps getting worse the longer this drags on.
Demand-side adaptation is ongoing: S. Korea has cut its Middle East crude dependence from 69% to 56% by pulling more from the Americas and Africa, and Japan is kicking off a second round of SPR releases from 1 May. But SPRs are finite.
Ref. to the negotiations, we should not bet on speed. The current Iranian leadership is dominated by genuine hardliners willing to absorb economic pain and run the clock to extract concessions. That is not a setup for a rapid resolution. US/Israeli media briefings keep framing the delay as ”internal Iranian divisions”, the reality is more complicated and points toward weeks and months, not days.
Our point is that the complexity is large, and higher prices have only just started (given a scenario where the negotiations drag out in time). The market spent April leaning on the USD 90/bl rest-of-year assumption; that case is diminishing by the hour. If ”early May reopening” is replaced by ”June, July or later” over the next week or two, both crude and products have meaningful room to reprice higher from here. There is a high risk being short energy and betting on any immediate political resolution(!).
Down on Friday. Up on Monday. The Brent June crude oil contract traded down 5.1% last week to a close of $90.38/b. It reached a high of $103.87/b last Monday and a low of $86.09/b on Friday as Iran announced that the Strait of Hormuz was fully open for transit. That quickly changed over the weekend as the US upheld its blockade of Iranian oil exports while Iran naturally responded by closing the SoH again. The US blew a hole in the engine room of the Iranian ship TOUSKA and took custody of the ship on Sunday. Brent crude is up 5.6% this morning to $95.4/b.
The cease-fire is expiring tomorrow. The US has said it will send a delegation for a second round of negotiations in Islamabad in Pakistan. But Iran has for now rejected a second round of talks as it views US demands as unrealistic and excessive while the US is also blocking the Strait of Hormuz.
While Brent is up 5% this morning, the financial market is still very optimistic that progress will be made. That talks will continue and that the SoH will fully open by the start of May which is consistent with a rest-of-year average Brent crude oil price of around $90/b with the market now trading that balance at around $88/b.
Financial optimism vs. physical deterioration. We have a divergence where the financial market is trading negotiations, improvements and resolution while at the same time the physical market is deteriorating day by day. Physical oil flows remain constrained by disrupted flows, longer voyage times and elevated freight and insurance costs.
Financial markets are betting that a US/Iranian resolution will save us in time from violent shortages down the road. But every day that the SoH remains closed is bringing us closer to a potentially very painful point of shortages and much higher prices.
The US blockade is also a weapon of leverage against its European and Asian allies. When Iran closed the SoH it held the world economy as a hostage against the US. The US blockade of the SoH is of course blocking Iranian oil exports. But it is also an action of disruption directed towards Europe and Asia. The US has called for the rest of the world to engaged in the war with Iran: ”If you want oil from the Persian Gulf, then go and get it”. A risk is that the US plays brinkmanship with the global oil market directed towards its European and Asian allies and maybe even towards China to force them to engage and take part. Maybe unthinkable. But unthinkable has become the norm with Trump in the White House.
Oil product price pain is set to rise as the Strait of Hormuz stays closed into summer
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