It was a quiet Monday for oil as the market traded in a tight range. Oil (NYMEX:CLQ13) sold off early on Chinese data but rebounded late in the day on U.S. data... It was obvious though that the bulls and bears lacked conviction, so the market seemed to just give in to the recent trend. It probably helped that OPEC as reported by Dow started to drop hints of a December production cut, yet that might be too early to worry about. So it is obvious that the market needs some reassurance and who better to provide that then Federal Reserve Chairman Ben Bernanke himself.
Without any real fresh news to drive oil it appears that most markets are awaiting Ben Bernanke’s testimony Wednesday at 10:00 a.m. before the Senate Banking Committee and Thursday at 10:30 a.m. The Humphrey Hawkins is considered key to try to determine just where Ben’s head is at when it comes to tapering after the market freaked out when Ben dared suggest that the Fed could taper down Fed purchases. Then we rallied when he tried to assure us that he does not mean that the Fed still would not be highly accommodative. He and other Fed Governors also said that if need be they would taper up or taper down based upon economic data. Now with the stock market pushing new highs and oil pushing $106 it will be up to Ben to keep the party going. Bank of England's Executive Director for Markets Paul Fisher seemed to slam Ben Bernanke this morning saying that “U.S. market reaction to potential Fed tapering shows the need for clear communication” Oh sure, put more pressure on Ben Bernanke. Thanks a lot Paul.
RBOB futures pulled back a bit after Friday’s panic buying run-up. We saw whole sale prices pull back dramatically yet the market still feels very nervous. While supplies are abundant in some parts of the country, in other parts we are running on fumes. Bloomberg reported Valero says a fluid catalytic cracker and alkylation unit are returning to planned rates at Wilmington refinery in California. Valero has no timetable for restarting a fluid catalytic cracker at its Port Arthur, Texas, refinery, Bill Day, spokesman for Valero in San Antonio, says in interview.
Now breaking this morning Bloomberg reports Phillips 66 Bayway Refinery Performing Unplanned Work. The company declined to identify units involved in work, duration of maintenance.
Robert Campbell of Reuters writes that “The United States has plenty of gasoline and a surfeit of crude oil. But in the case of both commodities supplies are much tighter when it comes to the specific grades that are acceptable for delivery against the main futures contracts.
The case of West Texas Intermediate crude is better understood. Some analysts have been attributing the market's move to a sudden realization that a combination of factors long known to many players was in fact happening. If this is the case, those appealing to this sort of logic have to admit it is difficult to explain why last week was the trigger instead of any other time. More likely last week was simply a short-covering frenzy. The smart money had already known that Cushing was now in a structural supply deficit due to new pipelines. It also knew that linefills were going to take up a lot of oil this summer and, indeed, at the end of this year and the start of next when another 8 million barrels will go into new pipes.
The simple fact is the futures price reflects a vastly tighter outlook for a very narrow category of oil: The specific type of crude that can be delivered against WTI futures at Cushing, Oklahoma.
This is where the concept of basis risk comes in. Hedgers may see a well-supplied market for oil but are stuck with a tool that reflects something very different: A tight market for WTI. This explains the dramatic backwardation in the WTI curve while crude stocks in most of the United States are at relatively high levels. The futures curve is tracking more closely the availability of a specific grade of crude at a specific place.
Of course, this is exactly what a futures contract is supposed to do. The value of a given barrel of oil cannot be separated from either the value of the products it yields upon distillation or its location.
Pipeline dynamics, specifically take-or-pay contracts, that obligate shippers to use new pipelines that drive WTI-type crude away from Cushing are the key factor here because it is not so much that there is a shortage of WTI-type oil but rather there is an expected shortage of WTI-type oil at Cushing.
But this "shortage" has as much to do with the positions in futures markets that are currently open. Massive short positions underlie the huge open interest in WTI contracts and support the speculative length that has helped drive the price of WTI sky-high. As futures positioning adjusts and fewer Cushing-area refiners opt to process costly WTI-type crude, this shortage will correct itself. Much of the same issue is currently playing out in the gasoline market. U.S. gasoline stocks are healthy, well above year ago levels and, in places like the Gulf Coast, seemingly in excess. Yet the price of RBOB futures has soared and the forward curve has become even more heavily backwardated. Why?
Some of this has to do with the rally in crude. But a closer look at the market suggests here too is a basis risk situation. Take East Coast (PADD 1) gasoline stocks. At 62.6 million barrels, the supply on hand is more than 9 million barrels over inventories a year ago. Much of this surplus is concentrated in and about the New York Harbor, the delivery point for RBOB futures. Gasoline stocks in PADD 1B, the part of the east coast nearest the Harbor, are nearly 31 million barrels, more than 7 million barrels over year-ago levels. With the peak demand season already upon us this surplus ought to be comfortable.
But is it? Perhaps gasoline as a whole is healthy but the supply situation for RBOB, the type of gasoline blendstock that must be delivered against the NYMEX futures contract, is less so. RBOB stocks stood at 19.7 million barrels in PADD 1, seemingly comfortable at over 5 million barrels above year ago levels.
The cash market is sending a different signal. Barges of RBOB in the New York Harbor are now trading at a substantial premium to RBOB futures, indicating a scramble for supply at the delivery point. Prompt physical RBOB now fetches more 5.5 cents/USG over the futures price, having moved up suddenly in recent days after weeks of languishing near parity or at a discount to the futures price.
This is probably due to operational problems at the Irving Oil refinery in St John, New Brunswick in Canada, a major supplier of gasoline to the northeastern United States, as well as the lingering effects of run cuts by European refiners.
RBOB production in the Northeast is also on the decline due to refinery closures. The shutdown of Hess' HES.N Port Reading facility, a 70,000 barrels per day fluid catalytic cracker located in the New York Harbor itself, is the most recent example. So it is possible that we see a similar phenomenon play out in RBOB to that seen in WTI already. Physical tightness of the grade that can be delivered against the futures contract masked by broader oversupply leading to a short-covering rally.
Of course in both cases, if the futures markets are ultimately being driven by highly local supply and demand factors, the broader markets will adjust. Non-deliverable grades will fall in price relative to those that can be delivered against the futures contract, encouraging end-users to switch where possible as well as stimulating higher production. The real risk here is borne by futures investors and those using these futures products to hedge exposures to the broader market. A refiner with plenty of gasoline on hand may have sold a lot of RBOB short only to be hit because RBOB deliverables are tight. A similar situation can be imagined for WTI. The unwinding of these short exposures may add a further, temporary bid to the market. But ultimately the lesson may be that hedgers, and speculators, must be more aware of the basis risks underlying these products than they have been.” Interesting take by Robert Campbell.
Natural gas rebounds as the markets focus on the heat in New York and a soaring cash market. Dow Jones reported that Natural gas for delivery at Transcontinental Zone 6 traded at $3.8614/MMBtu on Friday but is at $5.2137 today as the region has begun a run of afternoon temperatures in the 90s, a scenario forecasters expect to persist all week. On top of that as Reuters reported last week the owner of the Transcontinental Gas Pipeline Co LLC received approval on Friday from federal energy regulators to startup a segment of a natural gas pipeline expansion project this weekend. Williams Cos Inc. had requested approval to start the new segment so it can reroute supply to customers while performing some work on another segment. The company had said in a June 28 filing that if it was unable to place the pipeline section into service by the weekend "existing delivery obligations could be negatively impacted." On Thursday, a company spokesman said it would not take its line out of service this weekend unless it received approval from the U.S. Federal Energy Regulatory Commission to operate the new segment. The work is related to the Northeast Supply Link project, an extension of the Transco line designed to transport around 250 million cubic feet per day of gas to markets in Pennsylvania, New York and New Jersey. The full 10,200-mile Transco pipeline has a capacity to deliver some 9.8 billion cubic feet per day of natural gas from the Gulf Coast to the Northeast.
The Wall Street Journal in a must read writes “More than $160 billion of bets placed by international oil companies including Chevron Corp. and Exxon Mobil Corp. on natural gas in Australia are getting riskier, as the country becomes the latest major energy producer to grapple with North America's surging output of shale gas. Once a global hot spot for energy investment due to its political stability and large, untapped natural-gas reserves, Australia's appeal has waned as labor shortages and a high Australian dollar have triggered cost blowouts at flagship projects. Although those problems have been around for a while, they are becoming more worrisome now that gas prices elsewhere have dropped and buyers have more options for securing energy supply. "The industry has more than US$160 billion of liquefied natural gas investments currently in flight [being built]. But upward of another US$100 billion in potential future projects could be at risk," Chevron Australia Managing Director Roy Krzywosinski said.
Australia has long harbored ambitions of becoming the major liquefied-natural-gas, or LNG, supply hub for Asia and has over a dozen projects either under construction or on the drawing board. The seven terminals currently being built should allow Australia to leapfrog Qatar as the world's biggest LNG exporter by 2018. However, further supply additions may prove harder to achieve. Costs are rising sharply and first cargoes are being delayed at existing projects, hurting returns on investment. These problems are making companies wary of expanding or building new projects in Australia.”