The Phil Flynn Energy Report
It’s All About the Glut
It’s all about the glut, no oil. It’s all about the glut. No oil, all about the glut, no oil. The oil market has been held back in recent months by concerns that slowing demand would somehow create an oil glut keeping oil prices low. Yet if you start to look at the physical oil market, that narrative might be starting to fall apart.
Reuters reports that the physical crude oil market and the structure of the oil futures curve have rarely been more aligned over the past few years than in recent weeks, and they tell a counterintuitive story of a tight oil market next year. They say that while OPEC and the International Energy Agency point to a swelling oil glut next year due to booming non-OPEC supplies including in the United States, the physical market offers a different story. Reuters reports, "traders are prepared to pay near-record premiums for sweeter barrels as new marine fuel regulations from 2020 encourage refiners to switch to crude grades that produce smaller quantities of high-Sulphur fuel oil. However, premiums for heavier grades, which produce more fuel oil, also continue to rally due to a deficit created by U.S. sanctions on Iran and Venezuela. In addition, the structure of the oil futures market shows that premiums of front months to later dates – known as backwardation – have narrowed in recent weeks, also suggesting the market’s expectations of a glut are diminishing somewhat.”
This article does confirm what we have been writing about in recent months and confirms our bullish base case scenario. In recent weeks we have seen some wild swings in price on outside news but now it is possible that the oil market is finally waking up to the fact that the oil market is much tighter than many think it is. The main reason we gave was we were seeing a constant underestimation of oil demand. It seems that the oil market has been oblivious to what has been near-record demand and instead seemed more focused on concerns of slowing trade. Yet what we are seeing is demand, that is not only been resilient but is actually growing faster this quarter than last. Now add to that stimulus kicked into the global economic system and yesterday’s confirmation by OPEC that they were going to keep cuts in place along with Russia until June, and this could create a system-wide shortage. Not to mention that the world is short of diesel going into the IMO rules.
Reuters says that “Soaring physical crude prices are also negatively impacting refining margins, often prompting refiners to cut processing. New marine fuel rules have created a rally in certain crude oil grades. From January 2020, the United Nations’ International Maritime Organization (IMO) will ban ships from using fuels with a Sulphur content above 0.5%, compared with 3.5% now, unless they have Sulphur-cleaning kits called scrubbers.”
So while oil, after yesterday’s spectacular rally, puts us at major resistance and we could break from here, that break should be bought. Hedgers should remain hedged as the product market could get dicey.
Sometimes weekly oil inventories can get dicey. One of the biggest questions and frustrations I get and oil traders get is why the Energy Information Administration and the American Petroleum Institute, that report on the same data, seem to be so different every week. I put that question to the awesome EIA man Robert Merriam and he was happy to try to explain.
Mr. Merriam said, "these are some of the key reasons that we suspect that I’m aware of. In general, I’d say that our respective estimates in most weeks are reasonably close, and reasonable analysts might disagree about whether those relatively minor differences in most cases are even meaningful given that both API and EIA have some level of estimation in our methods, but they're certainly have been some notable exceptions.
However, you should ask API about their processes on that. I know some of the key folks at API who put out their weekly report, and I have high respect for them. He says that "reporting to EIA, both on a monthly basis and for those weekly sampled firms drawn from that monthly universe of relevant entities, is mandatory for all in-scope companies. It is true that most of EIA’s weekly sampled companies voluntarily opt to also send their reports to API, but certainly, not all of them choose to do so. Some of those who do not include API in their reporting might be relatively large players. As a result, API most likely must impute for those firms. He says that “While EIA’s weekly response rate is quite high, often approaching 99% most weeks, both EIA and API must impute values for any non-respondents in a given week. (I don’t know what API’s sample size is or their non-response rate.) However, it is likely that EIA and API use different statistical methods both to estimate values for non-respondent firms and also to impute (or not) for any questionable reported values that cannot be resolved or validated but which seem implausible."
Mr. Merriam says that "both EIA and API must estimate for non-sampled weekly companies, roughly only about 10% or less for most elements. EIA uses all companies’ monthly reporting to derive that estimate; i.e., EIA knows exactly who those non-sampled firms are and what their contribution is to the latest monthly volumes that form the basis of our non-sampled company estimates. API does not have that full, complete monthly company reporting and so they most likely have to make some assumptions in deriving how they will estimate for non-sampled companies.”
Merriam says, “I’d say those are probably the main reasons that often account for what are usually relatively small differences between our respective weekly estimates.” Thank Mr. Merriam once again!
Natural gas had a bigger draw than expected as that blast of winter gave us a shock. The EIA says that working gas in storage was 3,638 Bcf as of Friday, November 15, 2019, according to EIA estimates. This represents a net decrease of 94 Bcf from the previous week. Stocks were 506 Bcf higher than last year at this time and 60 Bcf below the five-year average of 3,698 Bcf. At 3,638 Bcf, the total working gas is within the five-year historical range.