An Oil Market In Therapeutic

A narrative of speculators and provide

For the oil market, 2023 has been a narrative of the facility of speculators and upside surprises in provide. To this point, it has paid to fade speculative positioning, whereas those that have underestimated manufacturing have paid dearly.

On the provision facet, as we will see beneath, Saudi Arabia’s manufacturing cuts did not actually make a lot of an influence on whole OPEC+ manufacturing (and subsequently on OPEC+ exports) till the July/August interval of this 12 months. It was this transient drop in manufacturing that noticed the market tighten and, in flip, resulted in stock attracts which brought on the bearishly positioned hedge funds and CTAs to start out protecting shorts and in the end seeing WTI rally from the mid-$60s to mid-$90s.

Sadly, not solely was this important drop in Saudi/OPEC+ manufacturing and exports comparatively short-lived (with OPEC+ manufacturing having elevated by roughly ~700,000 bpd since August), however non-OPEC+ provide continues to shock to the upside on the again of file US manufacturing regardless of a number of years of underinvestment. Whereas the beneath chart relies on the EIA’s month-to-month US oil manufacturing statistics (that are way more dependable than the weekly manufacturing estimates they produce, however far much less well timed), all indicators level to October and November manufacturing having exceeded expectations.

And naturally, along with file US manufacturing serving to to offset Saudi manufacturing cuts and Russian export cuts, Iranian crude oil manufacturing continues to extend on the again of lax sanctions enforcement to the tune of round 500,000 bpd above seasonal averages.

In the meantime, it appears the Russians solely briefly caught to their 300,000 bpd exports cuts in July and August earlier than returning to the three.3-3.5 million bpd mark as costs rallied to their highs in October.

October and November are additionally typically bearish months for oil and power costs, as this era is submit the northern hemisphere summer season driving season and customarily sees refinery runs drop as refinery upkeep picks up, in addition to the annual Mexican oil producers Hacienda hedge.

In all, the story of upside surprises in provide coupled with a interval of weaker demand has seen seasonally adjusted stock attracts shift to stock builds over latest weeks, coinciding with the latest drop in costs.

Because it stands, the present stock image stays bearish. Not solely are we seeing stock builds larger than seasonal averages, however whole crude and petroleum stock ranges at the moment are now not beneath their respective seasonal averages. When it comes to refined product inventories, it’s encouraging to see gasoline attracts return to the market these previous few weeks, whereas diesel shares stay at worryingly low ranges because the market stays tight as a result of a mixture of decreased Russian diesel exports and decreased manufacturing of Saudi heavy/bitter crudes (that are typically simpler to refine into diesel versus gasoline).

On account of these bearish dynamics taking part in out over the previous month or two, immediate futures spreads have been pushed right into a state of slight contango for WTI and Brent, together with Brent CFDs and DFLs additionally shifting into contango. That is seemingly confirming the notion that the market is now not as tight because it was, with a contango time period construction additionally incentivising stock builds versus stock attracts

All these components left oil weak to a speculator-driven sell-off. That is precisely what occurred and why being attentive to hedge funds and CTA positioning out there has paid handsomely this 12 months. Managed cash was caught close to file brief on the backside in July, and subsequently close to file lengthy on the prime in early October.

Traditionally, such extremes are nearly all the time glorious alternatives to each take earnings and enter longs. Fortuitously, we’re as soon as once more nearing excessive bearish ranges in managed cash positioning, which means the draw back is maybe restricted from right here, barring exogenous shocks reminiscent of an OPEC+ manufacturing improve.

On the entire, this can be a very constructive improvement, with this week’s Commitments of Merchants launch prone to report additional liquidations of speculative longs and/or a rise in shorts.

One other means I prefer to measure positioning is thru the lens of managed cash longs as a share of managed cash open curiosity, which, as we will see beneath, is reaching washout ranges for WTI. Sadly, the identical can’t be mentioned of refined product positioning. Managed cash continues to be impartial gasoline however very lengthy diesel. This is sensible given the relative tightness of the diesel market, but in addition suggests the asymmetry within the diesel market is to the draw back at current.

If we flip our consideration now to among the indicators of the bodily market, we’re seeing constructive indicators underneath the hood. Most notably, gasoline crack spreads are within the technique of therapeutic after collapsing all through September and October. Falling gasoline cracks have been all the time going to influence refinery runs to a point (and thus crude demand), even when diesel/jet gasoline margins have remained engaging.

In the meantime, the specter of Chinese language inventories being launched onto the market and thus capping costs has seemingly come and gone. This dynamic was central to my thesis as to why it appeared unlikely we might attain triple-digit oil costs this 12 months. Chinese language on-land inventories look to have peaked round 1,000 million bbls mid-year, earlier than being drawn down as costs rallied into October. Chinese language inventories now sit kind of at seasonal averages for this time of 12 months.

Whereas Chinese language demand definitely hasn’t been as excessive as some predicted following their reopening, I believe it’s honest to say Chinese language demand is doing okay. And whereas Chinese language imports are sitting at common ranges for this time of 12 months, the Singapore gasoil vs Dubai crack unfold stays at pretty strong ranges.

Whereas the Dubai/Brent EFS is close to parity, suggesting Asian demand is proving strong (with Dubai crude relative to Brent typically performing as a proxy for Asian demand given Asia is the marginal purchaser of Dubai crude).

Having mentioned all this, the arbiter for oil volatility at current is, after all, the OPEC+ assembly set for later this week.

OPEC+ first lower manufacturing in October 2022 to the tune of two million bpd, which was adopted up by a voluntary 1 million bpd lower by Saudi Arabia this 12 months along with a pledge by Russia to scale back exports by 300,000 bpd, each of which have been prolonged to the top of 2023. However as we mentioned earlier, precise manufacturing has been inconsistent versus OPEC+ quota (with the UAE and Iraq being a few the opposite main culprits).

I ought to preface this part by first saying I’m not within the enterprise of attempting to foretell OPEC’s strikes, nonetheless, have been I to do such a factor, my evaluation is it appears possible OPEC will on the very least chorus from making any will increase to manufacturing, and even perhaps suggest additional manufacturing cuts or enact higher enforcement of present manufacturing quotas.

It’s no secret Saudi Arabia desires costs larger and immediate spreads in backwardation such that we return to seeing stock attracts. Backwardation additionally disincentivises promoting of futures as a result of destructive roll yield, in addition to advantaging OPEC Nationwide Oil Corporations which might’t/do not hedge (i.e. promote ahead) their manufacturing to the extent that US producers do.

As as to whether they should lower, OPEC’s estimates of demand for the primary quarter of 2024 are way more bullish than that of the IEA or EIA, as we will see beneath. Thus, for them to agree on additional manufacturing cuts would appear to contradict their evaluation of the present steadiness of the market and ensure the notion the market will not be as tight because it was in Q3.

As well as, the associated fee OPEC+ pays for additional cuts shall be within the type of the continued ceding of market share to US producers within the Permian, which means there’s a important threat for Saudi Arabia, particularly, ought to any further cuts or extensions to current cuts not spur a market rally sooner or later within the upcoming mentioned cuts. This places OPEC+ and Saudi in a tough place, given there are incentives for each chopping and rising manufacturing, although I believe the cuts will proceed to win the day for now.

All in all, the oil market is in therapeutic

Placing all of it collectively, the state of the oil market is on stable footing. A variety of destructive forces have pushed costs decrease because the early October peak, within the type of speculative promoting, seasonally weak demand and an oversupply of gasoline (each of which resulted in decreased refinery runs), a rise in OPEC+ manufacturing/exports in addition to market makers promoting futures in opposition to the hedged of Mexican oil producers.

These forces are most likely nearing their crescendo, and given we stay in a comparatively impartial market (maybe a slight deficit), issues are trying brighter. Demand continues to be strong, and people deciphering this sell-off as a recession sign look like drawing a misinformed conclusion. Having mentioned that, provide has been and can most likely proceed to be ample to satisfy demand for probably the most half for the following 12 months or so. Any further OPEC+ manufacturing lower may assist shift the steadiness additional towards deficits by means of Q1 of 2024, although any manufacturing improve by OPEC or Saudi Arabia would have me flip comparatively bearish for the foreseeable future.

Ought to we see crack spreads proceed to heal themselves following gasoline’s important post-driving season stoop, this could assist improve refiner throughput and thus slowly however absolutely put speculators ready the place they flip from sellers to patrons. As well as, I might additionally prefer to see immediate spreads flip again into backwardation, a washout in refined product positioning and, most significantly, persistent stock attracts for crude and petroleum merchandise alike, a mixture that may go a protracted approach to fuelling one other materials rally in crude. For now, persistence is required, and for these trying so as to add to long-term fairness holdings, it appears nearly as good a time as any.

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