The FreightWaves oil report: markets do something they hadn't done for nine years

Photo: Jim Allen/FreightWaves

Photo: Jim Allen/FreightWaves

A weekly look at what occurred in the oil markets of the U.S. and the world this past week.

Oil markets Thursday completed a nine-day stretch of rising prices before reversing course Friday. But consider that on Friday, the business media was getting all excited about the S&P 500 having posted five consecutive days of gains. The nine-day run was the first of that length in nine years, almost to the day.It brought WTI prices up from a December 27 settle of $44.61 per barrel to settle Thursday at $52.59/b, before pulling back to  $51.59 Friday.

What pushed prices higher? You can take your pick among these possible reasons:

--OPEC cut its output in December by anywhere from 460,000 barrels per day to a whopping 630,000 b/d in December, the latter figure being reported by S&P Global Platts after earlier reports by Reuters and Bloomberg put the cuts at lesser levels. If the Platts numbers are closer to reality, it means that OPEC is already more than 75% of the way toward its output reduction goal of 800,000 b/d, agreed to at its early December meeting. But that isn’t the right way to look at it. As Platts noted, if you take out Qatar, which has quite the group and assume no reductions from Iran, Libya and Venezuela which were exempted from the reductions, the output level of 26.89 million b/d is still about 1 million b/d more than the 25.94 million b/d ceiling that is part of the agreement which went into effect January 1. However, that’s a big if: Venezuelan output continues to fall because of chaos, Libya’s biggest oil field is shut down because it was captured by a rebel group and Iran continues to labor under U.S. sanctions, though exemptions granted to eight countries by Washington means that its reductions in production have not been anywhere near what some market analysts expected. The OPEC cutbacks combined with strong statements from Saudi officials were viewed as key factors in the rising market.

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--The dollar is weaker. There is an inverse relationship between the strength of the dollar and the price of oil. Since oil is priced in dollars worldwide, a weaker dollar tends to boost the price of oil. It is not an absolute direct correlation, but it is a factor. Between December 14 and January 10, the value of the dollar relative to the euro declined to 86.4 cts per Euro from 89.1 cts per Euro on December 14. For the Japanese yen, a dollar could buy you 114 yen on November 28, but at its low on January 10 would only bring 104.8 yen.

--Hedging reversed. As has been noted previously, the enormous amount of hedging that needs to be done by U.S. exploration and production companies has introduced volatility in the market. In a falling market, the financial institutions that sold the “put” options to the E&P companies need to start selling futures to keep themselves balanced, or what is known in the options world as “delta neutral.” When the price starts rising, it can bring in additional selling. The bottom line is that the huge amount of hedging that is going on out there means that any move, up or down, tends to be exacerbated in the short run.

--But to the downside, the question is why prices are moving higher when the fundamentals are showing weakness? There were two statistical points that emerged during the week that pointed to a weaker market. First, for the second consecutive week, the weekly inventory report of the American Petroleum Institute and the Energy Information Administration of the Department of Energy showed enormous builds in U.S. stocks of gasoline and diesel.  Stocks of all distillates are soaring, including ultra low sulfur diesel, which in the latest report was about 88% of the total distillate pool. At 124.3 million barrels in the latest EIA report, inventories have caught up to their five-year average for this time of year. According to the EIA data, they’ve tacked on 20 million barrels in just two weeks after being considerably below then 5-year average. Meanwhile, crude oil stocks have been declining as U.S. refiners have been running in excess of 95% of capacity since the end of November. What looked like a crude glut is turning into the makings of a product glut.

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--The other key bearish number in the diesel market was the EIA’s weekly estimate of “products supplied”—essentially demand—for all forms of distillate. At 2.955 million b/d for the week ending January 4, it was the first time in about three years it was less than 3 million b/d. It could be an aberration, and a warm winter in the northeast is certainly keeping heating oil demand weak. (Heating oil, like diesel, is a distillate). But when combined with the high operating rates of refineries and bulging stocks, the possibility that demand is faltering makes a lot of sense.

--The price of diesel on the CME is for product a month hence. But in the physical market, what gets traded is generally barge or pipeline lots for delivery in a far shorter time frame. That market is showing signs of that inventory overhang. Platts reported that Gulf Coast diesel was 9.5 cts less than the CME ULSD price, which is much more than the usual differential of a few cents, and that jet fuel in the Gulf, which like diesel is a distillate, now is priced higher than diesel. That’s a reversal of the normal relationship between the two.

--The Deepwater Horizon blowout in the Gulf of Mexico threatened the very existence of BP. This past week, more than eight years later, it announced an enormous discovery in the Gulf. The company said that using new technology, it has “identified” an additional 1 billion barrels of oil in place at Thunder Horse, which already is a significant producer for BP. The Thunder Horse system can process 250,000 b/d of oil now. BP gave no timeline on adding to current production given the fact that these are only reserves. But the key takeaway here is that what BP said is cutting edge technology allowed it to process seismic data and make its conclusions in a matter of weeks. In the past, it would have taken a year.