Weekly Crude and WTI Oil Market Summary: Brent falls below $100 for first time in 9 months.

15/Apr/13 - 19/Apr/13

In the week preceding this, announcements form major international energy organisations adjusting oil demand forecasts downward caused a massive sell-off of the energy commodity, and the trend continued this week as economic data continued to cause prices falls in WTI and Brent. Brent lost -3.3% and WTI -3.6%, with Brent maintaining its premium as the spread closed yesterday at $11.6, the same level it opened at on Monday. Notably Brent closed below $100 on Tuesday for the first time since July, but failed to maintain a rebound above $100 on Friday.

Weekly Summary

Weak economic data showing Chinese GDP growth failed to meet expectations caused plunging Brent and WTI prices on Monday, with the grade failing to rally in European afternoon trading as US data confirmed economic weakness there as well. Due to the Chinese data, Brent opened in European trading $0.4 below its previous close, and then continued to lose -1.9% in trading. WTI meanwhile gapped down a similar amount but fell a larger -2.5% in trading. Further demand forecasts were cut by the World Bank, which reduced its growth forecasts for East Asia and warned of potential overheating, which would require central banks to raise interest rates. While the sell-off caused Brent to fall to its lowest close since August 2012, markets were more focussed on Gold which lost a massive 10% in one day of trading. The fall was caused by a bearish reaction to signs that indebted governments, such as Cyprus, may have forced to sell hard gold assets in exchange for financial bail-outs.

Crude continued to fall overnight in Asian trading, and Brent lost $1.7 from its Monday close to open in Europe at $99, similar to WTI which lost $1.3 overnight. While the grades rebounded in European trading, with Brent gaining 1% and WTI 1.5%, the earlier falls meant that Brent fell below $100 for the first time in 9 months. The European within-day rebound was similarly seen in other commodity markets, which may have been caused by a fall in the USD and a feeling that the previous drop was too much too soon, prompting some buyers to take advantage of the lower prices.

Such a move was ill-conceived however, and crude plummeted again on Wednesday in a reaction to the weekly EIA release showing increasing production and falling demand. For more details on the release, see my weekly inventory post. Bearish sentiment also entered the market as US corporate earnings came in at disappointing levels, and the USD strengthened from its previous fall, gaining 1.3% versus the euro. The bearish report and negative correlations with such currency gains caused Brent to fall -2.3% and WTI -2.4% on the day.

WTI and Brent had both closed below their lower Bollinger band on Wednesday, which as the graph shows in previous sessions had caused a next-day rebound which was demonstrated again on Thursday, prompted by further technical support from the RSI being below the 30-mark (see my previous technical trading post for more on the RSI). Such signs typically see buyers enter, even if for short-term profits. Signs of longer-term profits were also seen as the long bearish run raised the expectation that OPEC may begin to feel an output cut is necessary. Venezuela is particular announced concerns on Thursday, and with the country under political turmoil following a disputed election, there is a strong incentive for the government to secure higher oil prices and thus budget revenues. Despite the next OPEC meeting not being scheduled until 31^st May, prices could rise in the interim as Shell declared force majeure on its Nigerian Light Bonny crude for pipeline repairs and data shows seaborne exports from OPEC will fall in the four weeks to May 4. Rises in Brent and WTI could have been higher were it not for economic activity indicators out of the US coming in negative.

Reports that an ad-hoc OPEC meeting could be held boosted Brent on Friday, but apart from that a lack of notable data traders had a comparatively quiet day, with WTI falling a -0.4% and Brent up 0.2%. By the afternoon, OPEC had denied the announcement and Capital Economics pointed out most OPEC nations are comparatively healthy after recent high oil prices, and so urgency may not be on the cards. PVM, an oil-broker, suggested that the week-end rally is likely to have been caused by a closing of short positions before the weekend and for profit-taking at the $100 mark, resulting in the North Sea blend dropping back to close at $99.65.

Week Ahead

Next week will be quite data-heavy, with a number of global data releases being released. In the US,  everyday next week promises a release that normally moves markets, with home data on Monday and Tuesday, goods orders on Wednesday, the regular weekly jobs update on Thursday and a first-release of Q1 GDP data on Friday. China will see its monthly PMI first release early on Tuesday, which will be of particular note as the indicator has a high correlation with GDP, therefore giving an indication of how Q2 GDP could develop. The euro area first-estimate PMI will also be released after China’s, which could bring the euro zone back into focus again, particularly with investors waiting to see whether the ECB will engage in full-blown QE. This will be followed by the German IFO on Wednesday, which gives an indication of business confidence the euro area’s largest economy. On Thursday UK GDP data will be releases.

On a technical view, investors will be waiting to see whether the current situation is a temporary retracement on a continuing bearish run, or whether we have now hit the bottom and be aligned with fundamentals. Some analysts say $85 would be an appropriate price for WTI, while OPEC in particular may not be happy with less than $100 for Brent. Given current fundamental infrastructure issues between the two grades ( see “On a path to convergence”) mean a spread of closer to $10 than $15 is appropriate, we’ll have to wait and see to find out which grades gives in. For more detailed technical analysis, look out for tomorrow’s week-beginning technical update.

Weekly WTI Crude Oil Inventory Analysis: EIA release of 17th April

Summary of today’s release: last weeks’ change in Crude Inventories figures:

API: -6.7m

EIA Consensus:  +1.2m

EIA actual: -1.2m

Crude continued its bearish run today, with both grades dropping by more than 2% in the face on an EIA report that continued to remind traders of the fragile demand and supply situation in the US. While overall crude stocks dropped, the cause of this fall seemed to be a reduction in imports rather than an improving US demand situation. Indeed, the detail showed that US domestic production had increased while refinery input decreased. These factors, combined with a large stock-build at Cushing and a fall in distillate and gasoline products supplied to consumers, reinforced the current bearish outlook.

Detailed Breakdown

US domestic crude production climbed 27,000 barrels to reach 7.2mb/d last week, while net refinery input dropped by 40,000 b/d. The fall in refinery input only represents a 4% drop in the gains seen over the preceding 4 weeks, and could be a result of the continued softness of crude product demand in the shoulder period between winter fuel and summer gasoline peak demand. Such a demand situation was confirmed in this release, with gasoline product supplied falling by 94k/d and distillate fuel by -226k/d.

The bearish reaction to the drop in stocks may also have been caused by details in the regional breakdown. Despite the -1.2mb fall, the region that caused this decline was the demand heavy West Coast, where stocks fell by -1.8mb. Meanwhile, there was a 1mb rise at Cushing, with stocks there reaching the highest point since January. With a lot of traders focussed on transportation bottlenecks, such a sign is worrying as it implies crude might be finding its way to Cushing but not onward to the Gulf Coast. Such an idea may have been affected by the recent completion of the line-fill of the Longhorn pipeline, which was completed last week. This process was taking up some crude from the system, but actual deliveries are not expected until this week, and so this could have caused the temporary build-up (For more on that see my previous post Seaway No Solution).

How Markets Reacted

Brent has been on a bearish run since 2^nd April, when the grade reached $111.8 before dropping by $14.1 to end today at $97.7. WTI began its bearish run a few days earlier, falling from $97.7 to reach just under $87 today. Clearly there is a bearish sentiment in the market, and as in other weeks we’ve seen market reacting positively despite a negative headline number, this week we see markets reacting negatively despite a positive headline number.

As the chart shows, the Brent price initially ticked up slightly at 14:30 GMT after the release, but soon dropped by about $0.90 as analysts saw the details and continued to drop by a further $0.5 before rebounding slightly after the European closed. WTI followed a similar pattern, and both grades dropped on the day.

Outlook: How Low Will It Go?

US production reaching a 20-year high was hailed as a major headline by some news outlets, but in reality we already saw that headline a few weeks ago, and will likely continue to see it this year. As regular followers of the EIA report will know, the details can be overshadowed by the current market sentiment, with what we’ve seen over the past two weeks of a bearish market possibly being a correction to the previous weeks in which crude has increased endlessly despite bearish details and a loose market. Hence it’s difficult to predict next week’s release, but crude will likely rebound at some point, albeit perhaps temporarily.

In particular, technical indicators such as the RSI show that WTI could be due a rebound before the end of this week. As the day-chart below shows, WTI has reached a new low while the RSI has failed to reach a lower low than the one two days ago. This is known as an RSI bullish divergence, as detailed in my previous post of technical trading strategies.

Crude Oil Technical Strategy: Trading the Relative Strength Index (RSI)

Read oil market news and you're bound to come across references to technical analysis, which is viewed by many traders as an important tool in predicting price changes and signalling market momentum. While most will say that technical analysis should be used as a confirmation of fundamental views, there are many traders who claim to have successfully implemented trading strategies based solely on quantitative and technical analysis. In the first of a series of posts, I'll be looking at whether a simple momentum indicator can be used to create a profitable oil trading strategy.

The first indicator we’ll look at is the Relative Strength Index (RSI). The RSI is a momentum oscillator; it cycles between a value of 1 and 100 and measures the trading-momentum of a security.  A higher measure indicates a security could be overbought and a lower number oversold. (For more on the calculation of the RSI, check out this article at Investopedia.) A rough guide is that anything over 70 represents the security being overbought, and anything below 30 represents oversold. A potential strategy therefore can be to go short when the reading is over 70 and go long when its below 30. While there are plenty of articles out there discussing the strategy for stocks and currencies, how does the strategy play out for crude?

To take a first-look at the strategy, I’ve downloaded a price-set from EIA and created a 14-day RSI for the beginning of 1986 to the beginning of 2013. Using a VBA-script, the file loops through the data and works out the return from a buy and sell strategy in which the upper and lower RSI limits vary, thereby allowing for values of the upper and lower bounds to vary around the 30 and 70 marks. 

The table below shows the results. The non-strategy return, that is buying crude on day 1 and selling on the last day, results in a return of 389%; an equivalent annual rate of 6.1%. As the highlighted cells show, the best strategies are located around the (30-40, 76) limits or the (40-44, 60-64) limits, with the two best results being (44, 62) and (40, 76).

When using the (40,76) options for the lower and upper limit, there are only 88 days when the RSI is over 76 but 1208 when it is below 40, out of a total 6828 days in the data set; thus the strategy is almost entirely just predicting a few key selling points. In contrast, the (44, 62) presents a more-even strategy as there are 1829 buys and 1259 sells. (44, 62) however is a long way from the orthodox 30 and 70 mark; so is RSI really applicable in this case, or are we just getting lucky?

The truth is, the RSI alone is probably not going to give us a profitable trading strategy. As OptionAlpha points out, a more powerful indicator can actually be an RSI divergence. This is when the price reaches a higher high (lower low) but the RSI fails to reaches below its previous high (low). Graphically we mean something like below (taken from OptionALpha). This could explain why less extreme RSI thresholds are actually giving a better return. Alternatively, it may be we need to combine the RSI with another indicator to give a better indication of possible trends. In fact it’s common to use the RSI with a moving-average indicator; something we'll look at in more detail in the next post in this series.

Brent-WTI Spread Update: On a Path to Convergence?

The WTI-Brent spread has been big news for traders since the beginning of the year, and the spread has cycled in an $11.8 range since January 1st. As the chart below shows, the premium started the year at $19.4, fell as low as $15.5 in mid-January and then rose back up to $23.2 in early February. Since then the spread has dropped dramatically, falling by $9.4 since March 5th, closing on Friday at $11.4. The question is what’s caused this reversal in the last few weeks? And will Brent’s premium over the US blend continue to fall?

A variety of factors have been behind the recent narrowing of the Brent-WTI spread. Firstly a look at Brent: The North Sea grade was priced at $118 in mid-February, but the price has since dropped to $104.1. Yet there has been only slight signs that economic growth may not be as strong as it was considered back then, which if anything could actually rise the expectation of monetary easing programs and thus go to increasing commodity prices. So what has caused this $14 drop? Supply fundamentals have been one reason; production that had been curtailed due to a pipeline leak has come back on-line, while some smaller fields are also planning crude deliveries in April, from none in March. In fact, North Sea output will be 15% higher this month than March; hence supply on the spot market is particularly loose.

Seasonal refinery maintenance programs in Europe and other continents have also reduced demand for the North Sea blend, while demand has also been affected by a potential South Korean decision to close a tax loophole that had previously allowed refiners in that country to claim a $3 tax rebate on each barrel of Brent crude, despite not actually paying the tax due to a free-trade agreement with European countries. The rebate, which came into effect in 2011, had resulted in an eightfold increase in South Korean crude imports from Britain last year to an average of 70,000 b/d. But the potential change in tax law, which was announced early last month, resulted in a fall in ships transporting oil to Korea.

Apart from the changing demand and supply fundamentals, the geopolitical risk premium built into the Brent price has also dropped, particularly with regard to the situation in Iran. BCA Research published a great graph at the end of March showing how the price of Brent deviates from a fair-value model they have in correlation with the level of Iran references on Google, such as news events. Indeed price deviations seemed to spike with these references and then fall in a lag, which would explain the fall in prices seen in the last week relative to WTI.  The borrowed-graph from the article is below.

It’s not just Brent’s fundamental situation that is changing. The supply infrastructure for US crude, with WTI as the main benchmark, has been rapidly changing this year as more and more crude is taken by road and rail in an attempt to relieve the supply gluts that had formed at various points in the supply chain, particularly Cushing where the benchmark price is set. These alternatives to pipeline transportation are expected to grow this year; for instance Warren Buffet’s Burlington Northern Santa Fe railroad company expects crude transport to increase 40% this year. Media also reported that Crude was being trucked out of Cushing all the way to the Gulf Coast, a method that can cost up to $20 a barrel. The start-up of the reversed Longhorn pipeline from the West-Texas Permian basin in March also resulted in crude being taken off the route that flows through Cushing, thereby reducing pressure at the price-forming point. The pipeline has to be injected with an initial 900,000 barrels of oil before flow can start, which itself thereby serves as a sort of storage.

All of these infrastructure changes are taking place at a time when US refineries typically ramp-up production in anticipation of the US summer season, when gasoline in particular is of higher demand and when the quality of the fuel has to be higher as well. Crude imports have also been phased out as more of the domestic crude becomes accessible to refiners, particularly to the gulf coast which has seen more and more domestic crude delivered to the region. Rail connections are also enabling East-Coast refineries, which typically import all of their crude input, to start taking some of the US-produced oil and thus limit supply gluts elsewhere in the country. As such demand for WTI has been increasing and demand for Brent has fallen.

The future for the Brent-WTI premium

Based on the current looseness of the Brent supply situation and a lull in the risk-premium that the grade has been experiencing in the last few months, I actually expect the main risk over the next couple of months to be that the Brent-WTI spread will widen, despite the continuing trend of narrowing. The US remains extremely well supplied, and while some new pipeline infrastructure will take some of the pressure off supply gluts in the Mid-West, these will simply be transferred to the Gulf Coast where more storage is available, but where many of the refineries are not actually set up to refine light sweet oil such as WTI. Brent meanwhile will likely find some strength over the coming weeks as refinery production ramps up and China may take advantage of prices that are $14 lower than their recent peak to replenish supplies. What’s more, the South Korean tax decision has been delayed for a further three months until July, which will support Brent prices.

Having said this, based on better mobility of US crude from rail and road, as well as increased demand from refineries, can we expect the Brent-WTI premium to move back down to zero towards the back of the year? The answer is no, this level of convergence will not be seen for a few years at least. In fact it’s important to note that despite improvements in mobility, the spread between Brent and WTI needs to remain at a level which continues to make rail movements profitable. Given the cost of transporting oil from Bakken in North Dakota to the East Coast is about $15, and that Bakken oil currently trades at around parity to WTI, we shouldn’t expect a fall in the Brent-WTI premium to much below its current level to be sustainable. In terms of other analyst’s forecasts, recent releases show that Societe General expects an average spread of $16 this year, and Morgan Stanley expects a spread of 14.50. Given this year’s current average is $17.7 so far, these forecasts imply the spread will average $15.4 and $13.4 over the remaining 9 months. I would say the latter seems more likely unless we see a re-ignition of the geopolitical risk premium.

Weekly Crude and WTI Oil Market Summary: An overdue price correction

01/Apr/13 - 05/Apr/13

Oil experienced its biggest weekly drop in six months this week as WTI lost -4.6% and Brent -5.4% from their previous weekly close. The cause of the drop was a mixture of weak US and Chinese economic data combined with a correction of prices in response to the looser supply situation, as US stocks reached a 22-year high. WTI continued to get support from the start of the summer refinery season in the US while the increase in Brent deliveries in April led to some price pressure for the European blend. Based On this, the premium of Brent to WTI dropped to close the week at a low of $11.4, not seen since June last year.

Weekly Summary

Weaker manufacturing data out of the US and China did little to support economic confidence in markets on Monday, and the early news from the East caused WTI and Brent to both gap down on their opening in Europe, where volumes remained low due to the Easter holiday. WTI lost $1.1 from its Thursday close to open at $92.4, and Brent $0.9 to open at $108.9. Despite the downbeat economic news, the resulting weakness of the USD actually provided support to oil during the day and Brent gained 0.8%. WTI however was hit by news that the Pegasus pipeline in the US, which forms part of a longer pipeline carrying heavy Canadian crude to the gulf coast, was shut due to a leak and big environmental concerns. The news meant more crude was likely to build up in the Midwest and thus put downward pressure on prices, causing WTI to fall by 0.8%.

US February factory orders came out as positive on Tuesday, but the main cause of the increase came from the volatile aeroplane orders component and consumer-durables, which masked a drop in the core orders that signal business investment. Despite the future outlook for investment looking fragile, the increase in consumer goods supported the WTI spot market which gained 0.3%.  Brent however lost ground, falling -0.4% on the day.

The after-hours US API crude inventories report came in extremely negative for markets, showing a 4.7mb rise. The EIA report on Wednesday confirmed a large rise, with the details explained in the weekly inventory analysis. With a number of technical indicators suggesting WTI in particular was overbought on Tuesday’s close, the rise in inventories to a 22-year high coupled with weak economic data to create an extremely bearish environment for both WTI and Brent. The US grade dropped -2.4% while Brent fell -2.9%. Many claimed the correction was long overdue, with the supply situation extremely loose at the moment. The higher fall in Brent resulted in a drop in the Brent-WTI premium, ending the day at just $12.6.

The downward momentum continued on Thursday, with WTI falling by -1.2% and Brent -0.7%, with the technical momentum combining with a weaker US jobless claims number to bring down expectations of growth and spending in the US economy.  

The weaker US job insurance claims number indeed translated into a weaker than expected US non-farms payroll on Friday. Given the indicators position as the most-watched indicator of the month, the negative effect fed into markets where WTI lost -0.9% but Brent lost -2.3%. Weak euro zone retail sales continued to remind traders about the delicateness of the European economic situation and thus Brent demand, while progress from Iranian negotiations about the nuclear situation in that country may have reduced Brent’s risk premium. Meanwhile WTI continues to gain support from the start on the US refinery system despite concerns of the Pegasus pipeline, and the Brent-WTI premium dropped to a low of $11.4, not seen since June 2012.

Week Ahead

Oil may have fallen further this week on supply and demand fundamentals were it not for the fact that the employment situation in the US means the Fed’s QE program will continue for longer, given their targeting of the unemployment rate. This fact resulted in a weaker dollar, which led to some support for USD priced commodities such as oil. Having said this, markets seem to have realised that oil was simply priced too high given the supply situation; a great graph which demonstrates this is the US day’s ahead supply chart as shown below. Clearly, this year’s supply levels, which on this chart takes into account the level of demand as well, is much more elevated than previous years.

Such facts could mean oil may fall weaker this week, but interestingly it’s Brent’s technical indicators that show an indication that the grade may be heavily oversold rather than WTI, which had rallied strongly in the preceding weeks. As the graphs below show, Brent has finished below it's bollinger band on Friday, and the RSI has dropped below 30. Meanwhile, WTI still seems relatively strong on those indicators because of its strong rally the previous week. Indeed, now might be a good idea to buy Brent, given Saudi’s position as a swing producer for global Brent means the nation won’t let supplies increase too high, and given Libya’s continued production problems and Iraq’s indication last week that supplies probably won't be as high as some forecast. WTI meanwhile is benefitting from pipelines being built that themselves hold a large amount of oil and will transfer supply gluts in the Midwest to the Gulf Coast, but if there simply isn't demand in the midwest then prices will once again rise. Most of all it’s important to remember that a lot of US crude is now being shipped by rail, a transport method that costs a lot more than pipeline or ships and thus we would expect a much higher average Brent premium over the year as pipelines are being built – so be careful of expecting the premium to fall much below the $10 range.

Weekly WTI Crude Oil Inventory Analysis: EIA release of 3rd April

Summary of today’s release: last weeks’ change in Crude Inventories figures:

API: +4.7 mb

EIA Consensus:  +2.2 mb

EIA actual: +2.7 mb

A mostly bearish oil inventory report was met strongly on the downside by an overbought oil market, prompting a strong correction today for both WTI and Brent prices. The headline stocks increase resulted in a rise in inventories to their highest level in 22 years, and this combined with a generally negative sentiment across markets to result in the highest daily loss for oil markets in 2013 so far.

Detailed Breakdown

Markets have previously reacted positively to overall crude inventory rises so long as stocks at Cushing had fallen. However this was not the case today; Cushing supplies dropped by -287,000 - now 2.68 mb below the peak in early January. Instead increases came from other parts of the Midwest, PADD2 region, as well as the Gulf Coast. Part of the drop in stocks at Cushing can be attributed to the current filling of the longhorn pipeline, which must be done before oil gas actually be transported to refiners and has diverted some of the flow from Cushing. However media also reports oil is now being trucked out of Cushing to connect with rail and water transport.

The fine details of the report actually had several positive, albeit subdued, signs; refinery utilisation increased 0.6%pts to 86.3% and demand for gasoline rose 1.5%. A fall in distillate stocks despite lower demand and higher production also implied a healthy export market for refiner’s products. Day’s supply, which measures the stock level of crude compared to current demand, also dropped by 0.3 days despite the increase in stocks due to the rise in demand for crude from refiners. Hence this provides support to the idea that markets were making an overdue correction today rather than responding specifically to this one report; markets after all should react to the differences in demand and supply level, indicated by day’s cover, rather than an absolute supply level.

How Markets Reacted

As mentioned in the last few weekly report summaries, in the past few weeks markets have been picking up only on positive aspects, rather than to overall supply fundamentals. This week a correction has finally occurred with prices falling sharply, furthermore the strong level of momentum behind this indicates the trend could continue tomorrow; Brent fell -3% with trading volumes double their normal level, and WTI fell -2.8% (see chart below) with trading volumes over 30% higher.

While technical indicators were already giving overbought signals before the EIA release, it tends to take a strong showing of fundamental messages to spur the market into such a strong fall and indeed the bearish EIA report coincided with bearish economic indicators out of the US. Some level of acceptance that a geopolitical risk premium has been seeping away may also have contributed to the negative price momentum, with some analysts citing this as a reason to lower price forecasts.

Next week’s release

This week’s closure of the Pegasus pipeline, which links Midwest crude storage to Texan refineries, could add pressure to stocks next week. The pipeline normally carries 90,000 b/d of heavy Canadian crude, rather than light US produced crude, and therefore may not have an adverse effect on the US WTI prices.  Key details to look out for will be product demand, which will need to carry on increasing if supply gluts are not simply going to be transferred to other regions as pipeline infrastructure improves.