"Spreading" the Risk
Increased futures margins and changes to structure of USO holdings are having the desired effect: reducing the open interest in front-month futures. As of last Friday, open interest in the June 2020 WTI contract on the CME had fallen below that of the July 2020 contract and are significantly lower than the Open Interest of the May-2020 contract this same time last month.
CME margins have doubled for the front few futures contracts over the last 5 weeks prompting even more stringent requirements being imposed by it's clearing members (from $4,650 to $10,000 for the front-month contract).
Note however, that to hold a June/July 2020 calendar spread cuts that margin in half (to $5,000) and by more than 80% (to $1,475) if you move to the July/August 2020 calendar spread. However, the 12-month calendar spread (June-20/June-21, 1:1 ratio) requires greater margin coverage than the June alone (at $10,500).
It's becoming clear that holding an outright position in the June-2020 contract is going to be something only the well-capitalized can endeavor. This will either create a very volatile contract or a zombie contract as smaller players are forced to move further out on the curve to higher-priced, lower margin-ed contracts. It will also drive more spread-related positioning vs outright positioning.
We saw this in the June/July-2020 spread last week, which rallied almost $3 after May expiration (from -$7.12 to -$4.28).
Despite the negative close in the May-2020 contract on 4/20/20, the May/June-2020 calendar spread rebounded from an epic wide settlement of -$58.06 on that same to only to go on to expire at a mere -$1.56 contango. Hence, the rebound in the June/July-2020 spread.
As calendar spreads are a reflection of storage availability, this has left everyone questioning what value to assign to these monthly spreads. We believe the blowout of the May/June 2020 calendar spread can be attributed to an unexpected opportunity that caught mid-stream players off-guard. The combination of futures expiration and overall duress in the market left participants unable to react in time to operationally capture said opportunity (i.e. arrange to store oil for one month for less than the $58 contango presented on 4/20).
The difference between spot prices and July-20 futures had certainly narrowed (to less than $2 in WTI by the end of the week: $15.06 in spot vs $16.94 in June futures)).
Even the Dated Brent differential to Brent front-line futures managed to rebound off of their lows last week (from -$6.40 to -$4.15).
So, what does all of this mean? There are a few scenarios that come to mind:
Given enough time, the market was able to 'find' alternative storage space to lease for less than the calendar spreads were implying actual costs were,
The global market is recovering sooner than the US market, opening the door for US exports,
Production cuts are expected to lessen the need for storage capacity starting in June, or
The market only deals with the reality of physical delivery once a month and is kicking that can down the road until May 19th when the June-20 contract expires.
Point 1 is possible as reports of increased off-shore oil taker storage have continued to make the news. Point 2 seems less plausible given the narrowing of the WTI/Brent futures spreads since the loss of demand due to the virus began.
Point 3 carries a bit more weight given that the OPEC+ cuts begin in June and the declines reported to date by the EIA via their weekly storage reports.
Point 4 remains to be seen as June futures do not expire until May 19.
Bottom line, points 3 and 4 coupled with smaller positioning in front month futures due to increased margins will be responsible for significant volatility in the coming weeks. The market has become accustomed to pricing the supply/demand imbalance created by a loss in demand not yet met by a reduction in supply. The market is still trying to figure out how to value the yet-to-be implemented cuts in production. What does a 'balanced market' look like and how tenuous will it be?
US inventory levels by PADD vs total storage capacity by PADD:
The EIA reported another total inventory BUILD of 15.0 million barrels for the week ending April 17, 2020.
Year-to-date, this bring us to a Total Inventory BUILD of a record 87.60 million barrels! However, this has still not surpassed YTD inventory builds seen for the same week ending in 2015.
Inventory levels are shown below, compared to prior year levels for the same week ending as well as against total storage capacity. The record-breaker continues to be gasoline inventory levels.
Lee Taylor - Technical Levels
Resistance: 23.22 / 25.12 / 27.89
Support: 20.50 / 20.07 / 15.98
The Brent market seemed poised to break 28.28, but then the wheels came off across the energy complex. Support of 25.40 could not hold the onslaught of selling and finally made a new low of 16.07. June Brent will have to gather enough momentum to break above 25.12 - 25.40 before making any higher progress. June/Dec Brent made a new low of -14.43 then came back to break above 11.33, but will have trouble making it back to -9.04.
Resistance: 19.77 / 21.34 / 24.84
Support: 16.64 / 13.35 / 10.26
Two weeks’ ago, it was OPEC clamoring for unwanted headlines only to watch the USO fund say “hold my drink” this past week. Once May WTI expired, the focus shined on June WTI as it bounced off of an unthinkable $6.50. Short-term, June will have to hold 16.64 so that it can push to 19.77 – the 50% retracement level on the last move down. Look to sell any rally in June/July WTI as it nears -350
Resistance: .6952 / .7668 / .8536
Support: .6340 / .6056 / .5809
RBOB was set to take off last week, then it endured another setback as Pemex announced force majeure on deliveries coming out of the United States. Regardless of news stories, supply/demand levels or crude expires, one thing is for certain – May RBOB gasoline hasn’t been able to break above .7500 - .7741 since March 17th. In the meantime, it will linger in the mid-60 cent level. May/June made its first attempt to break above -392 to -378 but quickly came off. I feel as though longs will make another push up, however another failed attempt projects back to -600.
Resistance: .7794 / .8926 / .9426
Support: .7481 / .7214 / .7084
“If May heating oil is unable to stabilize this week, we could see a retest of its low set back in early 2016 of .8605” – a comment we made last week, however we never envisioned this. Support is small and comes quick if we have any more pressure on heating oil so keep those stops close. We were talking about the short side being profitable on June/July heating oil last week. Stay short it unless it breaks above -560 to -514.