Oil spreads narrow as supply issues are resolved

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The oil market (NYMEX:CLV13) has continued to react to the U.S. moving to a diplomatic solution for Syria with prices declining for the last three trading sessions. The soon to expire spot WTI contract is now less than $1/bbl off the next key technical support level with the Brent contract in a similar position relative to its technical support. The complex is currently searching for a stabilization level that is reflective of the ongoing supply issues that have been plaguing the market for the last several months. Until places like Libya return to more normal production levels, the downside for the oil complex will be limited relative to where prices are currently trading.

The November Brent/WTI spread has continued to narrow declining for the last two sessions in a row. Since peaking in early September the November spread has lost about half of its value and now less than $1/bbl of its next key technical support level. As the supply issues that I have been discussing for weeks start to resolve themselves the spread will resume its path toward parity. I am still of the view that the spread will trade at parity or even with WTI at a premium to Brent for a sustained period of time as the Cushing takeaway infrastructure continues to come on stream toward the end of the year and into early next year.

The bigger story in the world of oil spreads is the absolute crashing of the U.S.-based crack spreads… in particular the RBOB crack. The November RBOB crack has lost more than half of its value over the last 12 trading sessions. The spot RBOB crack is now trading at the lowest level since the end of November 2011. The supply situation for gasoline remains robust with current inventories well above both last year and the so-called normal five year average. With refiners running to maximize diesel for exports and heating oil for the upcoming winter heating season, gasoline is almost a byproduct at the moment as unneeded supply continues to hit the market.

As the markets anxiously await Wednesday’s U.S. Fed decision on whether or not to start tapering QE3, the global equity markets have continued to add value. The EMI Global Equity index is higher by almost 1% for the week with the year-to-date gain rising to 2.4%. Global equities have continued to be a price support for oil as well as the broader commodity complex.

Tuesday's API report was mixed with a slight bullish bias. Total crude oil stocks decreased less than the expectations by 0.3 million barrels even as crude oil imports decreased slightly as refinery run rates increased by 1.3%. The API reported a small draw in distillate fuel inventories and a draw in gasoline stocks that were outside the range of the expectations.

The oil complex is mostly lower as of this writing and heading into the EIA oil inventory report to be released at 10:30 AM EST Wednesday. The market is usually cautious on trading on the API report and prefers to wait for the more widely watched EIA report due out this morning.  On the week gasoline stocks decreased by about 0.6 million barrels while distillate fuel stocks decreased by about 0.2 million barrels.  

The API reported Cushing crude oil stocks decreased by 0.9 million barrels and at a pace about at the same level as has been in lay for the last several months. The API and EIA have been very much in sync on Cushing crude oil stocks and as such we should see a similar draw in Cushing in the EIA report. Directionally it is bearish for the Brent/WTI spread.

My projections for this week’s inventory report are summarized in the following table. I am expecting a draw in crude oil inventories with a build in refined products.

I am expecting crude oil stocks to decrease by about 1 million barrels. If the actual numbers are in sync with my projections the year over year comparison for crude oil will now show a deficit of 8.6 million barrels while the overhang versus the five year average for the same week will come in around 19.8 million barrels.

I am expecting crude oil stocks in Cushing, Ok to decrease modestly for the twelfth week in a row and continue its destocking trend and at a stronger ace than last week. This will be bearish for the Brent/WTI spread but with the geopolitical risk and supply interruptions in MENA the narrowing of the spread could be tempered.

With refinery runs expected to increase by 0.2% I am expecting a build in gasoline stocks. Gasoline stocks are expected to increase by 0.3 million barrels which would result in the gasoline year over year surplus coming in around 21.6 million barrels while the surplus versus the five-year average for the same week will come in around 13.1 million barrels. With the U.S. summer driving season now in the history books gasoline supplies are more than adequate going forward as total gasoline stocks remain well above both last year and the so called normal five year average.

Distillate fuel is projected to increase by 1.0 million barrels even as exports of distillate fuel out of the U.S. Gulf remains robust. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 5 million barrels above last year while the deficit vs. the five-year average will come in around 18.5 million barrels.

The following table compares my projections for this week's report (for the categories I am making projections with the change in inventories for the same period last year. As you can see from the table last year's inventories are not in directional sync with the projections. As such if the actual data is in line with the projections there will be modest changes in the year over year inventory comparisons for everything in the complex.

I am keeping my oil view and bias at neutral as the market continues to now focus on the new diplomatic plan to solving Syria’s chemical weapons issues. Currently market participants are in a Syrian risk premium shedding mode as they try to determine if diplomacy will work. For the moment Syria is likely to continue to work its way toward the background as a short term oil price driver.

I am maintaining my Nat Gas view at neutral and keeping my bias at neutral after last week’s bearish weekly inventory report. The fundamental picture could once again shift if the temperatures across the US does actually result in a significant increase in weather related Nat Gas consumption.

Markets are mixed heading into the Asian trading session as shown in the following table.

Best Regards,

Dominick A. Chirichella

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