Oh sure oil had a lot of reasons to break yesterday! China’s Wen Jiabao putting their breaks on the Chinese red hot housing market, OPEC raising production to aria and of course the rising fear that the Fed is getting closer to taking the punch bowel away, yet it was word of a hedge fund meltdown and some huge sell orders that made the rounds and the serious talk that some big hedge fund was blowing up.
Of course despite the news yesterday, oil was ready to break and readers of my report new that it was what we were expecting. But it seemed reluctant despite the fact that the precious metals were getting slaughtered. That changed late in the day when a reported massive sell order hit the market causing oil to drop hard. Reuter’s news reported that “Then something strange happened: The market for the most heavily-traded U.S. crude oil contract went quiet. For nearly ten seconds, not one contract crossed the ticker tape, intensifying the panic already gripping traders scrambling to find what had set off the decline.”
It was by no means a huge sell-off by historical standards. In early May of 2011, U.S. crude prices collapsed by $10 a barrel over the course of one wild trading session. Still, the speed of the $2 dollar slide illustrates how quickly the oil market can turn, surprising traders after months of relatively small price moves and low volatility. The episode also marks the latest in a spate of hiccups that have plagued market operators, prompting exchanges to put in place plans for halting trading during abnormal trading activity.
A spokesman for CME Group said the exchange did not halt trading in crude oil and that the markets functioned properly throughout the day. But that has prompted even more questions about whether an avalanche of computer-driven trading or human error disrupted Wednesday morning's session.
"We have a real mystery on our hands," said Eric Hunsader, founder of Nanex, a Winnetka, Ill.-based trading software company that tracks market activity. Nanex also noticed the spike in volume and the ten second pause shortly after 11 a.m. New York time. The affected trading instrument, an April contract for delivery of 1,000 barrels of U.S. crude oil, saw nearly two million barrels' worth of trading volume in a one-second interval at around 11:01 a.m., Reuters found. Volume had averaged about 13,000 barrels per second over the previous trading hour. The price of the contract fell from $95.47 to $95.05 just two seconds later. The price then ticked higher, to $95.16, before the market froze for about ten seconds. Trades reappeared shortly before the minute was out, and the market carried on with the volatile trading session.
The sell order also added to the talk that a huge hedge fund was blowing up. That type of massive sell order reeks of forced liquidation. Many hedge funds have been getting crushed and have seen many pull out as the money seeks yield in a rising stock market. While the rumor has not been confirmed, my guess is that where there is smoke there will be fire.
Also the Seaway Pipeline delays are adding to the bearish mood. Robert Campbell at Reuters says that a lot of work has gone into understanding the impact of expanded flows on the Seaway oil pipeline into Houston. In particular, many analysts have tried to ascertain how easily it would be for the Houston market to absorb the large volumes of light sweet crude coming in on Seaway but also via Eagle Ford and, soon, the Longhorn pipeline. Much of this analysis turns on the assumption that only light sweet crude is moving down Seaway.
But Campbell understanding is that Seaway is now moving approximately 100,000 bpd of Canadian oil sands crude. If so, that suggests the incremental amount of light sweet crude that has been introduced into the Houston market by the expansion of Seaway may now be as little as 50,000 bpd, or, put differently, light sweet crude flows into Houston on Seaway are only approximately 200,000 bpd today.
This makes sense. WCS trades at Cushing right now at about $12 under the calendar month average for WTI. Shipping heavy crude on Seaway, at the uncommitted rate, is $4.32, so WCS at Houston is worth roughly $88 a barrel, or about $18/bl less than the landed cost of Mexican Maya. Anyone who could process WCS (and, who had a pipeline connection to Seaway) would be jumping at those numbers. If you are turning $88 crude into products valued based on $115 Brent, it is big money. The obvious candidates here would be Phillips 66 at Sweeny (once out of turnaround) and ExxonMobil Baytown, assuming they can get WCS down the DOE line at Jones Creek. Indeed, the economics are so compelling — far more compelling than light oil — that it might be the case that WCS gains share on Seaway once Sweeny comes back.
If so, what are the effects? Well the overall volume impact on Cushing would be nil, although it would mean that less light oil was going out of there than previously thought. At Houston it would leave a bit more space for light crude in the refinery slates and reduce competition with EF and Longhorn barrels. It would also, presumably, reduce competition to get on outbound pipelines like Ho-Ho once they are in place. It would, however, slow the pace of declines in WTI-deliverable oil inventories at Cushing.
The API showed a build in crude! Bring on EIA!