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Where are the Margins?

(aka, margins imply demand)


Author: Brynne Kelly (w/Lee Taylor technical levels)


In a healthy global demand environment, US exports of crude oil were able to grow, which reduced US net imports of crude oil. Demand growth outside of the US relative to global supply was enough to make US exports a profitable venture (as seen via the WTI/Brent spread below, WTI shown as a discount to Brent, navy line). By mid to late 2018, Brent crude oil traded at a premium to WTI of between $8 and $10 even as US exports of crude oil rose. Since the start of 2019 however, the marginal impact of less US net imports (aka, more US net exports) began to impact the global supply/demand balance and the Brent premium went from $8 over WTI to just around $4 over. By April, 2020 Brent's premium to WTI shrank to a mere $3 per barrel margin before transport costs.


Real export spreads are actually even lower given that crude located near the US Gulf Coast trades at a premium to WTI. We see this via LLS/WTI continuous futures spreads (Louisiana Light Sweet). The first 6 months of LLS has been trading at around a $1.75 premium to WTI at Cushing. This leaves an export margin before expenses of less than $1.50/bbl ( WTI/Brent spread of -$3.25 plus LLS/WTI spread of $1.75).

At a spread of $1.50, exports aren't completely dead, but they certainly aren't anything to write home about. Nor are they an impetus for WTI prices to move higher. This needs to come from the demand side.


However, The IEA August Oil Market Report states that:


"Global oil demand is expected to be 91.9 mb/d in 2020, down 8.1 mb/d y-o-y. In this Report, we reduce our 2020 forecast by 140 kb/d, the first downgrade in several months, reflecting the stalling of mobility as the number of Covid-19 cases remains high, and weakness in the aviation sector. China’s oil demand is recovering strongly, up 750 kb/d y-o-y in June. We have revised down our 2021 global demand estimate by 240 kb/d to 97.1 mb/d, mainly due to aviation sector weakness."


With more than 7.7 mb/d in OPEC Cuts still in play until the end of the year, an increase in oil demand of 5.2 mb/d (from 91.9 to 97.1 mb/d referenced above) by the end of 2021 hardly seems noteworthy. In fact, for most large producers each incremental barrel produced is with exports in mind, as each producer is looking for the highest priced market to place their barrels. Like a game of whack-a-mole, any market that shows a relative premium will get hit with supply.


This is why oil prices have hit a wall, spreads that normally provide incentives for the movement of product around the world have collapsed.

Producers and refiners alike are waiting in the wings with spare capacity to pounce.


The US, to it's credit, has been managing domestic margins via net imports. Production was the lever used over the past several years to answer the call of increased demand. Now, the US is using net imports to manage any weekly supply/demand imbalances domestically.


We see this in US refinery production of gasoline vs demand. Finished gasoline supplied by refiners has returned to the low-end of the 10 year range.

Large weekly swings in net imports of gasoline shows how carefully supplies are being managed week-to-week, with net imports providing the offset to changes in US demand instead of organic production.


This has managed to stabilize the growth in US gasoline inventories, as refinery utilization has cautiously moved up to 81% (and even facilitated an inventory reduction from the highs seen in April, 2020).


In total, weekly product supplied by refiners (taken from the EIA weekly inventory reports) shows that we are just now reaching the low-end of the production range for the last 10 years.

Stabilization does not equal a clear path forward though. With demand now forecast to be relatively lackluster through the end of 2020 (see Bloomberg article), the best path towards a recovery in margins would be to hold back on refining and draw down product inventories to a point where product prices can lead the way forward.

This would keep demand for oil in the dumps for the foreseeable future, while allowing product 'shortages' to work their magic. Take a look at RBOB gasoline calendar strips for 2021-2023 vs the calendar strips for the same time period in WTI crude oil below.

At an average of $55 for RBOB gasoline and $45 for WTI, this puts gasoline crack spreads to WTI at an average of around $10/bbl for cal 2021-2023. This is certainly not the lowest level ever seen in gasoline cracks, but we don't see oil being able to move out of its $40-$43 range until gasoline prices firm up. This is a tall ask as we head into the 4th quarter of the year, a time when gasoline demand is at it's lows. If we don't see some strength in gasoline demand in excess of production, things could fall apart.



Inventory


Weekly Changes


The EIA reported a total petroleum inventory DRAW of 9.70_million barrels for the week ending August 7, 2020. Crude oil alone posted a weekly DRAW of 4.50 (excluding SPR).



Year-to-date, total Inventory additions stand at a BUILD of 136.10 million barrels (vs 145.80 last week). Still no need to make comparisons because YTD builds far exceed anything on record.


Commercial Inventory levels of Crude Oil (ex-SPR) and Refined Products remain elevated compared to prior years, with distillate inventories being the most worrisome ahead of the winter heating season.









Lee Taylor - Technical Levels


BRENT

Resistance: 46.36 / 48.82 / 51.16

Support: 44.27 / 42.89 / 41.57

This may be the week that we test the upside numbers for real. October Brent needs to break above 46.36 to finally establish a trend towards $50. Just like the $41.57 level in Sep WTI, Oct Brent will need to maintain 44.27 and rally most of the week. I have been bearish Oct/Nov Brent for several weeks expecting it to trade down to -.60; however, it may have run its course and shift momentum back to -.34

WTI

Resistance: 43.17 / 44.40 / 46.41

Support: 41.73 / 39.34 / 36.08

It is beginning to test my writing skills when one must speak about technicals in a market that has been toiling in a $6.50 range for eight weeks. Last week, the market continuously tested resistance in September Crude Oil of 43.05-43.09 to no avail. We all are aware of the tight ranges, low volume and decreasing volatility we have been experiencing in the energy markets, however, I can begin to see some positive signs. If October (Sep expires this week) CL can hold 41.73 on Monday and continue to follow the trendline north, it will have no choice but to break through the major resistance that the market has been looking up to.

RBOB

Resistance: 1.2736 / 1.3090 /1.3390

Support: 1.2237 / 1.1956 / 1.1789

The gasoline market may finally lead us into the promised land.After two months (late June) of being stuck in a fifteen-cent range, it seems poised to break out.Late Thursday night, we began to hear stories of refinery closures due to poor economic conditions.Look for these key resistance levels of 1.3090 (old high from 6/23), 1.3161-1.3390 (covid gap) and 1.4199 (38.2% retracement level) as the market moves higher.

HEATING OIL

Resistance: 1.2654 / 1.2892 / 1.3023

Support: 1.2062 / 1.1817 / 1.1689

I do not see the same glimmer of hope in the heating oil market as I do for WTI and Brent. After finally trading into the Corona Gap back on August 5th, spot heat has done little else to excite the bulls. September heating oil broke under its trendline on Thursday when it settled under 1.2497. I understand that if the balance of the energy complex is in the midst of a small rally, it’s not smart to bear up on heat. However, if I am mistaken on crude then we will see October heat test 1.1734. I am still holding on to Sep/Oct heat with resistance at -202 with a downside objective of -264.

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