Saturday, 6 April 2013

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.





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