HEADLINE DRIVEN FRONT, MACRO SENTIMENT DRIVEN BACK.
AKA: NOTHING IS MOVING BUT THE FRONT OF THE MARKET AND CALENDAR SPREADS ARE FEELING THE PAIN
The 4th quarter of 2019 was marked by one simple thing: Headline Risk. Those risks included everything from IMO 2020, Chinese tariffs, the Saudi drone strike and the December OPEC meeting. As a result, month-one futures have displayed a lot of intra-day volatility.
However, as breath-taking as the increases in oil prices were in 2019 (up a whopping 35% from the lows), the average producer that sells at index (or hedged downside risk with options) has only realized a 4% gain over the last 2 years (fig. 1). During that same two-year period, term markets (aka: the back of the curve) have barely budged with calendar 2021-2022 strips essentially unchanged (fig. 2)
This price action in the front has put eyes on equities in the oil & gas space. The rise in front-month futures is trying to translate into some sort of optimism regarding the fate of energy companies. The market knows that roughly $200 billion in North American oil and gas debt will mature in the next four years, according to the Wall Street Journal, which includes $41 billion due in 2020.
Yet, while month-one WTI futures are up over $16.00 on the year, the calendar 2021 strip was only up a scant $2.50 in 2019 and the calendars 2022-2023 strips are essentially unchanged. This doesn’t bode well for the valuation of overall ‘reserves’, which is the lion’s share of a producer’s value.
To add insult to injury, product crack spreads (gasoline and heating oil at a high level) are not providing any leadership in term markets. We see the same scenario playing out: month-one futures have been volatile, but term markets are under pressure (fig. 3).
Zooming in a bit on month-one crack spread futures, we see that for all the ‘noise’, we have still landed at or below levels seen this time a year ago and even two years ago (fig. 4).
As a result, the market ‘play-book’ has been to buy weakness in calendar spreads and sell strength (fig. 5). The green line is the current front-month spread (Feb/Mar). This has been decidedly range-bound between around $0.20-$0.40 since the Saudi drone strike. Regardless of outright prices, these spreads are bought on weakness and sold on strength. It’s also been typical that the front-month spread in WTI has weakened into expiration.
This appears to be the case again with the Feb/Mar spread. HOWEVER, what’s different is that since November of 2019, the more distant spreads (Jun/Jul & Nov/Dec, for example) have continued to make new highs. We find this more significant than outright price direction. Here is the issue: if market participants have been spreading by buying the front of the market and selling months 3-12 against it, there could be (or we could have seen) an unwind of this as participants look to re-position their calendar spreads further out on the curve (i.e. roll a long in Feb/Jun to Jun/Dec, etc.).
So, let’s review. WTI futures (as shown in fig. 1) are not at 2019 highs. Nor are term markets (oil calendar strips and crack spread term markets, figs. 2 & 3). In fact, the back of the market continues to play into the hands of the ‘over-produced and lack of demand growth’ narrative. Yet, many calendar spreads are making new highs (fig. 5). We saw that after the Saudi drone strikes, calendar spreads blew out and people had to cover, driving spreads to new highs. Those spreads are now higher than they were after a major attack on one of the world’s largest producers!
We know that the front month spread is now entering the window of the fund roll period which render it irrelevant as a market signal. But, if term spreads continue to strengthen, BEWARE. There will be no end to short-covering spread activity and new spread length positioning in WTI. This has the potential to then fan the flames on outright prices as increasing backwardation is traditionally viewed as bullish. Yet, no one is ‘bullish’ oil on a long-term basis. Hence spreads get stuck in a range. It’s a vicious cycle that might finally be coming to a head in 2020. Meaning, have we gone just one headline risk too far to stay within recent price spread ranges??
Brent is looked to as a leader in price rallies as it signifies global demand. While Brent prices did rally in 2019, the rally was 10% less than WTI’s 35% move higher. We see this in the Brent/WTI month-one futures spread which ended the year lower than where it began (fig. 6).
The question one must ask oneself is ‘who is the leader in this market’? Product crack spreads are lower, benchmark spreads are lower (Brent/WTI), yet backwardation is making new highs. Is this the moment where spreads once again retreat because the front of the market is sold off, or will they eventually retreat because the back of the market will catch up? If it’s the latter, there are more new highs to come in calendar spreads.
The EIA inventory report for week ending December 27, 2019 reported total inventory BUILD of 0.60 million barrels with Crude oil posting a net DRAW of 11.40 million barrels.
Year-to-date, US inventories are now Down 18.88 million barrels.
Inventory levels are a tough one to gauge at year-end due to LIFO and accounting activity mention in our December 15, 2019 report. As expected, oil inventories ended the year lower than where they were at this time last year compliments of higher prices and the mechanics of LIFO and Ad Valorem tax motivations.
Lee Taylor - Technical Levels
February Brent is also making its move to the upside. Next level of resistance is 70.32 from mid-September with support underneath at 68.48. The 70.32 level will act as major resistance – if broken will surely set off another round of short-covering and new length. The issue with Brent spreads now is that March/April has now gapped higher from Friday’s high of .88 to today’s low of .90. If the market falls back and fills the gap, we should see a quick sell-off of profit taking. Next level of support in March/April is .83 and .65 in April/May Brent.
Resistance: 64.80 /66.60
Support: 63.73 / 63.38
Amid the weekend’s tweets, threats of retaliation and escalating tensions, February WTI has taken out another level (63.73) on the weekly charts. The next level of resistance is at 64.80 then 66.60. The $66.60 level is a bit off and will probably only come into play if retaliatory strikes occur or continued strikes from our side. The key focus should be on support numbers of 63.73 or 63.38 – if market can hold these levels then the market can build momentum to the upside. The two front spreads are having are lagging flat price as resistance keeps a ceiling on Feb/March WTI at .28 and March/April at .38.
Resistance: 1.7856 / 1.8134
Support: 1.7656 / 1.7594/ 1.7440
The RBOB market is becoming difficult to understand as it’s obviously following WTI and Brent on the Geo-political news, but there is a major divergence going on internally. Yes, flat price rallied on the news Thursday night into Friday and have shown strength on tonight’s opening; however, spreads are struggling to follow flat price. February RBOB has support at 1.7656, 1.7594 then 1.7440 with resistance above at 1.7856 then 1.8134. Feb/March has struggled to break above -110 and when it did, it quickly fell back underneath. Please look at March/April as it has major support at -1760 to go along with a relatively (no pun intended) low RSI of 40.59. This spread may be the one to lead RBOB out of the doldrums.
Resistance: 2.0905 - 2.0922 / 2.0156 / 2.0999
Support: 2.0782 /2.0618
Heating oil has experienced the same issues as WTI and RBOB as it has obviously rallied in flat price but has struggled to maintain and spread strength. February Heating Oil has resistance above at 2.0905-2.0922, then 2.1056. Please note that there is major weekly resistance above at 2.0999. Support is found below at 2.0782 then 2.0618. As we have discussed for several weeks, heating oil spreads have been under attack and technically was pretty straight forward. The issue in heating oil is that both Feb/March and March/April have been under pressure and haven’t mirrored flat price; however, Feb/March is completely overdone with an RSI of 23.79 and March/April of 39.30. Watch these two spreads as they may be the hidden treasure this week in the energy complex.