AUGUST 2018 in review
Published 18 SEPTEMBER 2018
The market has been a typical tricky summer month, with swings in Open interest and event driven price action. Going forward on the trading side, we will be looking at high percentage trades within differentials. With China taking less or no barrels from US into their own refineries then we expect the exported oil from the US to point towards Europe, adding light sweet barrels an already struggling light sweet market. Given the demand from heavies from China and heavy crude from Iran falling off the market, the highest percentage trade we can see in the crude market is shorting light heavy differentials. This can be reflected in either short the CPC vs. Urals diff or shorting the more liquid Brent/Dubai contract. Next the high Brent flat price will mean the price for shale crude will need to give, namely the WTI Midland differential to WTI and consequently the WTI/Brent Futures differential as increasing local light sweet production finds its way to Cushing.
The physical oil and derivatives markets were mixed throughout August, however the overall futures complex closed out the month as the standout performer. Flat price is higher, time spreads are higher, but the physical related crude derivatives are still under pressure from the market. The uptick in the physical came from the sour barrels as new import quotas from the East and Iranian rhetoric lent support. The sweeter barrels remained under pressure, with Med sweet barrels failing to clear below set OSPs. Strong refinery margins and high utilization rates have held strong over August, hinting at a lack of refining capacity as stocks remain depressed globally.
WHERE ARE WE NOW?
WEAK EUROPEAN MARKET
European crude grades were a mixed bag throughout August, as sour barrels gained strength and lighter grades held weak as the month unveiled. Local barrels of Urals and Forties saw strength from the East as import quotas from China pulled the barrels out of the region and concerns over Iranian exports gave traders a reason to seek alternatives. However, the lighter grades continue to be dampened by arbitrage pressure from the US, as the barrels previously facing Asia turned to Europe with fresh world trade concerns.
Weak Dated Brent BENCHMARK
The European benchmark held relatively constant over August, averaging a settle of -1.11 compared to -0.86 in July. The physical and the paper assessments followed similar trajectories, starting the month strong, dipping in the middle of the month and ending relatively unchanged.
The derivatives market showed strong signs of pressure, however, the consistent futures strength from mid-August onwards overcast the sentiment in the market, and so it was left reeling in a disjointed fundamentally weak North Sea market and a bullish futures market. This was in part due to a French major taking the majority of October loading BFOE cargoes. This forced a lot of North Sea traders to exit short positions in the Brent futures and hold their exposure in the Dated Brent contracts only, potentially hedging their short Dated position with long futures positions.
The Brent futures market began to align with the underlying crude market for the first half of the month, with convincing contango in the benchmark rolls and the futures time spreads. For the remainder of the month, the futures regained all losses with the Chinese pull for crude and the concerns over Iran pulling the floating barrels of BFOE.
Strong deferred products, underwhelming pricing and strong paper refinery margins
The product market was disjointed over August, with deferred support from the East and generally weak pricing across the barrel. EIA data was concentrated on strong rising stock levels for middle distillates, and a mix with Gasoline initially building and then drawing. We would have expected gasoline to draw more consistently for this time of the year, but given the dependably high utilization rates, the builds were in line with our projections for August.
Light end cracks came under pressure for most of the month as underwhelming expectations for summer began to become realized. Distillate cracks were the better performers of the barrel, with refinery outages from Reliance’s FCC unit giving support to the cracks. This in turn transpired as support to the sour heavy crude barrels in Europe. Fuel oil, although still performing relatively well at -$10/bbl, came under some pressure towards late August.
Refinery margins held profitable throughout the month, supported by small outages in Europe and strong cracks in the East. This was partly in line with our expectation that they would hold from weak crude prices only, but, a lot of the crude differentials strengthened, and high refinery utilization sustained and therefore we would conclude the uptick was due to lack of refinery capacity.
US returning to reality
After a strong summer for WTI, the benchmark crude is returning to its norm and reacting more fundamentally than we have seen in a while. The US market is still heavily reliant upon clearing their physical market via exports, and their internal transport system is still underdeveloped, with gluts of crude forming in the Permian and Cushing. This has become evident with Cushing starting to build, and the WTI Midland to WTI differential falling to lows of -$18/bbl.
WEAK ASIAN MARKET
We again expect a revision down in OSPs for crude grades that clear to Asia but expect those heading to Europe to remain. We are in an analogous situation to July, where the physical struggled to clear at discounts to already-reduced OSPs. This weakness in the physical market has again been realized in the Dubai benchmark, which has concluded August lower, however, like the futures and European market, it was at its weakest mid-month. The paper market, however, gained strength over the month. This price action was driven by skepticism regarding Iranian barrels but was exacerbated by market participants exiting short positions and re-entering long positions in Dubai time spreads. Evidence of genuine buying emerged at the end of the month, as the pricing spread picked up with genuine interest for cargoes by Vitol and Shell.
What did we expect last month?
Continued weakness in light product cracks
Underlying crude oil physical market to be under pressure
Overarching view: the crude oil market is fundamentally weak, and the physical and futures market will re align going in to the second half of the year
What did we SUGGEST?
Short VZ HO-Gasoline box
Short crude structure (ZM Brent)
Buy put option/Short Brent flat price (February 2018 put option)
HOW DID IT PAN OUT?
The box came under pressure, from 0.15 to 0.04
Structure and outrights came off aggressively over the first 2 decades of the month, and then retraced to end the month at
ZM Brent went from 1.13 to 1.55
Brent flat price moved from 74.39 to 77.64