The second day of selloff continued even without a significant headline. There was a rumour that a fund liquidated all its long positions (around 15,000 lots) which prompted a downward price move and triggered other stops on the way down. Wednesday’s sell-off was primarily due to the bearish API and DOE stats which showed a record crude stock build. The rationale thought was that some of the current record open interest being held by the speculative long players would come down. However, the latest open interest on May and June Brent contracts showed a slight increase today despite the sharp price action on Wednesday. This means that the spec longs getting stopped out are getting replaced by other long players who are getting tempted back in by the lower price. Normally, in sharp price correction trading days we expect open interest to fall around 10%, but this time it’s different and its getting increasingly harder to understand volatility when oil futures is getting increasingly influenced by algorithms and high-frequency trading.
For people, who are tempted to buy these dips, take note of the technical gap in the Brent continuation chart which was formed after the last OPEC meeting. Technical gaps rarely remain open and the lows of today closed some of this gap but not completely. This gap needs to be closed ($50.49) before prices increase later this year. Saudi energy minister’s statements in Houston has begun to spook the markets. He has mentioned that OPEC cuts rollover in May is not a given. This is mainly a jab at Russia who are taking their time to fully comply. In addition, they have said they will not be there to cut production so shale growth can offset their cuts. Even though an OPEC deal is likely to be extended for another 6 months but there is no longer an OPEC put in the market and this will continue to make the market nervous.
The selloff in flat price continues to weaken Brent and WTI curve structure as well. Brent Dec17/Dec18 continues to remain backwardated (has continuously for the last 3 months) while WTI Dec17/18 flirted with a shallow contango before settling in backwardation. Shale oil drillers would love a steep contango to hedge their future production at a higher price. While Saudi and the rest of the OPEC want backwardation as quickly as possible to incentivise oil to come out of storage and reduce the record high stocks and make life harder for shale oil drillers.
The chicken and the egg game continues. We cannot get sustained and consistent backwardation with record high stocks especially in the US and we cannot run down stocks from tanks if the contango curve pays for the cost of storage. Today, all the near term timespreads in the WTI curve flipped back into contango while for Brent you must go further into 2018 spreads to see backwardation. The contango in the front months will penalise long only funds as the cost of rolling the contract every month will eat into their returns. Until we don’t get sustained backwardation, a big chunk of financial investors will watch the game from the side-lines.
Reuters ran a headline stating that US Energy department has awarded 10 million barrels of SPR crude to various bidders. The timing of this release is not clear, but this 10mln barrels will end up in the commercial storage which is already at record high. The SPR import cover is at around 140 days compared to the IEA recommended level of 90 days. We will see more SPR sales in the future. The SPR cost price for the barrels in storage is around $30, so even at these low-price levels it will bring in profit for the government.
European statistics were out today. European crude runs remain low as refiners entered maintenance in February and will continue to do so in March/April. The weak gasoline market has begun to pressure margins though we are still far away from run cuts. Stock levels remain at high levels and can be a worrying prospect if we see weak refinery margins in the future. Product stocks especially diesel remain high and should be a concern for the near future.
An interesting tweet by the International Energy Agency today regarding how efficiency equalled half the growth in electricity generation. Oil efficiency has not been as progressive like electricity efficiency, but there will be one day when oil efficiency due to new cars/trucks/planes will meet half of all demand growth. The days of 1.5mmbd annual growth will seem like a distant reality and this is one of the reason why the deferred oil curve will continue to trade at low prices.
With oil prices in freefall in past 2 days, technical indicators have gained importance again. WTI touched its 200 day MA of 48.68 but it has bounced back straight away. Brent will continue to get tested from the downside and will get closer to closing gap at 50.49. The RSI for WTI is below 30 indicating a buy signal but it can fall to 20 before it is a buying opportunity again.