Chinese New Year + Coronavirus + IMO Unwind = "Risk Off".
As if last weeks 7%+ selloff in oil wasn't enough, crude opened another 3% lower on Sunday night! Every so often we encounter a confluence of events that simply break the back of the market. Impeachment, recession, global contagion, election cycle news and a virus in China have all collided at that perfect moment in time with lighter volumes due to the Chinese New Year holiday.
As we attempt to unpack last week's oil market selloff we are mindful of the fact that tonight's down market open in the US is still somewhat speculative and it's a bit too early to attach any actual fundamental supply/demand data points to it at this point. Instead we will look at what was behind oil moves last week, namely:
- Low Sulfur to High Sulfur spreads
- Crack Spreads
- Calendar Strips
The first thing that stands out as a driver of market weakness last week is the collapse in low sulfur vs high sulfur spreads. This was the exact spread that blew out last year in anticipation of the new IMO 2020 rules and underpinned oil prices.
In the last few months of 2019, this spread got as wide as $45 per barrel before showing signs of weakness. This spread has fallen roughly $12 per barrel since the start of the year, of which $9 of that selloff occurred last week. The positioning that occurred ahead of IMO implementation is evident, as is the rush to exit that trade as speculation becomes reality as the market appeared to be better supplied for the change in regulations than initially expected. The weakening of this spread is certainly seasonal (and can be seen above in Q1 price action), and fairly common each year as we transition from winter to spring, however the selloff was much more prominent this year. The question in the weeks to come will be whether or not the markets reaction-to-date is overdone.
Noting the individual curves below, the spread sell-off wasn't driven purely by a move of lower ULSD prices. It was also driven by HSFO prices finding something of a bottom towards the end of last year as low prices attracted demand by those vessels that installed scrubbers.
Looking at the EIA projections for low sulfur vs high sulfur demand, it ironically lines up with market action. It makes one wonder what exactly the market was hoping would be different.
We now lay this against the backdrop of WTI month-1 futures:
As a result of the low sulfur price declines, HO cracks vs WTI have also taken a big hit this year. Below we show the April-October 'summer' crack spread futures in both RB (pink line) and HO (blue line) vs outright month-1 WTI prices (black line). We use the 7 month strips to avoid the noise created by the seasonal rotation from heating demand to gasoline demand.
Both summer cracks saw a decline last week, however it was the heat cracks that took the largest hit and made new lows. Gasoline cracks seem to be finding it is too early in it's demand season to give up yet and may provide some support for the market going forward.
Next, we look at 1-year calendar strips in WTI. The 2021-2023 strips closed out the week right at that $50 support level that we have seen hold for the last several years. We think this is a key area to watch. If this $50 area can't hold, the market could come unglued as hedgers panic.
Backwardation of the front relative to the back, however is still hanging in there and hasn't yet made new lows. An example of this is shown in the next chart of month-1 WTI vs the calendar 2021 futures strip. The market is toying with the idea of whether or not to add a storage incentive.
Storage incentives often show up in the market when future inventory levels are less certain than current levels. With the continued pressure on calendar strips over the last few years, the question of future production growth and shrinkage in capital expenditures has been out there.
Two key oil inventory storage regions are Cushing and PADD 3 (the US Gulf Coast). The next chart shows a comparison of the two over the last 6 years.
Neither storage location is anywhere near their highs, and with the uncertainty surrounding future production in a low price environment, its reasonable to ponder whether or not it's time for the market to provide a storage incentive. We don't think the market is ready quite yet given it's well-founded fear of over-production based on past experience and today's geopolitical environment. The key will be what we see in weekly inventory changes as we hit peak refinery turn-around season and what, if any market impact recent market sell-offs have on producers.
For now, we leave you with the next two charts that compare month-1 WTI futures to both Cushing and PADD 3 inventory levels.
The EIA inventory report for week ending January 17, 2020 reported a small total inventory BUILD of .10 million barrels with Crude oil posting a small net DRAW of .40 million barrels. Overall, the product inventory changes were below what was reported by the API and also below previous years for this same week.
Year-to-date, this bring us to a total Inventory build of 12.40 million barrels.
Inventory LEVELS compared to this same week in previous years show us slightly ahead in both gasoline and distillate inventories, but well below previous years Cushing inventory levels.
Lee Taylor - Technical Levels
The Brent market followed the WTI scenario as it broke through a weekly upward trendline last week of 63.69. A longer trendline from back in 2016 comes in at 58.91 (basis April) which was quickly broken at time of this report. That number should become extremely important this week as major support or resistance! If the weekly support number can’t hold then look for 56.13 as the next level to the downside. April/May has support below at .60 then .55 with resistance still above at 75.
The coronavirus has changed everything in the market as traders sell off any length due to fears of a major impact on travel and tourism, as well as many businesses in China. If this hits the US in force, the financial damage will be even greater. The major weekly support level is now basis March WTI and came in at 57.73 last week was easily broken on Friday. Our next objective of 55.62 was broken as well so next in line is 50.50-50.99. On the daily charts, 50.16 is truly the next level of support besides our weekly numbers. Our object on March/April WTI reached our objective of a contango market but more downside is expected to -.16
March RBOB, just like the rest of the energy complex, has struggled to have a sustained rally lately. The 1.6747 level above created a great ceiling for gasoline then once news of the virus broke, the next level of 1.6324 was broken. The trendline of 1.5744 was broken at the end of last week and the nervousness of Corona is guiding us towards 1.4501. Last week, RBOB spreads acted strangely as there was a lot of RBOB-heat spreads trading. In our opinion, there has been a great deal of false optimism for RBOB spreads. This week, it seems as though the outlook is how low can they go? Our prediction is -175 in GH, -1978 in HJ and -81 in JK.
March Heating broke through a major weekly support of 1.8406 last week. Well, no one could imagine but we may test its’ next level of weekly support at 1.6536 – that’s 20 cents in less than one week. Resistance comes in at 1.7402-1.7450. Heating Oil spreads will stay weak for the time being, and as we stated last week, the only troubling factor about their weakness is that the spreads have been way oversold and are running on a less than 20 RSI.