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Global Oil Spreads are the Key to Balancing US Oil Inventories

by Brynne Kelly

May 12, 2017

Just like the delicate balance between a strong versus weak currency, oil prices between OECD and non-OECD regions need to strike a balance.  US Exports to Non-OECD regions will be the key to balancing growing US production versus slowing US demand growth:

Since the last OPEC cuts were announced, WTI crude oil has gone from trading at a $2.50 premium to the OPEC basket price to discounts of up to $2.00 (see Figure 1).  With the export ban lifted, the US is now positioned to take advantage of a weak relative ‘currency’ (oil price) by moving US production to more expensive global markets.

 

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Figure 1.  Prices before vs after OPEC cuts

This is certainly the dilemma that OPEC faces going forward, starting with the upcoming May 25 meeting.  OPEC used to be the Gold Standard to which world oil prices were pegged.  As in 1971 when the world moved off the gold standard, so too is the world now slowly moving off the ‘OPEC-Standard’.  The shifting of the supply/demand picture between regions is forcing producing nations into ‘currency’ (oil price) wars.  At this point in the game, OPEC production cuts only strengthen their relative ‘currency’ (oil) in the short-term making ‘currencies’ (oil) from other countries more attractive to buyers.  The path to outright price inflation is becoming less clear.

The move in spread relationships among the various futures curves this past week (Figure 2 below) highlights the uncertainty in relative prices as the market awaits the upcoming OPEC meeting.   Will production in the US continue to find a home in growing global markets or will production from other countries be more price-competitive?  Notice that the back-end of the WTI and Brent curves gained relative strength to their Oman counterpart in the Middle-East and are actually up week over week.

Figure 2.  12 month futures price relationships

Is this an anomaly or a lack of confidence that US exports are viable at these levels?  For now, the price ‘wars’ will continue to search for a balance.

Inventories:

Weekly EIA Inventory figures posted a net Draw of 7.5 for the week ending May 5, 2017 (Figure 3).  The market finally got its much-anticipated draw in gasoline inventories of (0.40).

Figure 3.  Weekly EIA Inventory Statistics

EIA Inventory

To provide context, Figure 4 takes a look at inventory changes for this week over the past 3 years.

Figure 4.  Comparison of this week’s inventory change to prior years

With total inventory levels still at the top end of the historical range, it will take a lot more than this one week’s draw to change the overall picture.  If we simply take the average summer inventory draws over the past 3 year, September-end total inventory levels still look historically high:

Figure 4.  Comparison of this week’s inventory change to prior years

2017 end of summer crude oil inventory projection

Bottom-line, inventory statistics still aren’t providing a catalyst to break us out of the $45-$55 range.

What do Futures Curves tell us?

Crude oil futures prices for the balance of 2017 fell just under 1.0% this week and were essentially unchanged in the gasoline and distillates.  While gasoline cracks continued to hold their ground, Ultra Low Sulfur Diesel(ULSD)/Heating oil cracks also found a bit of a bottom.

In-line with things outside of the US gaining relative value, note that it was the non-US ULSD cracks that moved higher relative to their local crude oil market.  This makes sense given relative overall demand growth ‘US versus non-US’.  As WTI is the least expensive of the 3 benchmarks right now, US refiners are the winner in the product markets.

These relationships are helping move oil through the ‘system’.  The question is how much price incentive OPEC is willing to provide to non-OPEC producing nations.

With the next OPEC meeting 2 weeks away, markets appear relatively ‘status quo’ rather than ‘bracing for impact.’

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