JULY 2018 in review
Published 6 AUGUST 2018
The physical oil market weakened through July, and the derivatives market followed suit; flat price is lower, physical crude oil grades to their benchmark are lower and the prompt derivative market has weakened. New refinery margin crack hedging and prompt refined products pricing out weakly are further signals that the market is fundamentally weak, and, as we enter August, we will be holding this view and looking out for more bearish evidence.
WHERE ARE WE NOW?
WEAK EUROPEAN MARKET
The sentiment in Europe remained weak going into July, in line with expectations. Local barrels of Urals and BFOE continued to be dampened by arbitrage pressure from the US, exacerbated by a lack of workable outlets into Asia.
Weak Dated Brent and a non-transpiring August
The European benchmark weakened considerably over July. Sentiment heading into July was that the underlying market was weak but that scheduled field maintenance would provide support for August loading barrels, with potential for an uptick in the benchmark over the latter half of July. The prompt derivative market never saw this uptick, with only the physical barrels over the scheduled dates showing a strong disconnection from the derivative contracts. Generally, you expect field maintenance to support the benchmark, with Q3 barrels tending to price out stronger relative to the rest of the year in any given market condition. Considering this, the lack of a bullish move in the benchmark in July is telling of a fragile crude market.
As we expected, the futures market began to align with the underlying crude market, as it corrected downwards over the course of the month.
Strong Products and Refinery hedging
The product market showed strength over July, supported by strong product draws out of the US as summer demand prevailed, exacerbated by a gasoline refinery outage which created a tumultuous rally. Although this occurs cyclically, we expected the oversupply of crude to lead to oversupply in products almost immediately due to profitable refinery margins and high utilization rates. We have yet to see the full effect of the refineries running at maximum run rates, as it takes time to filter through to product supplies, but we saw strong indications of refinery hedging. However, the prompt pricing of products remained weak, especially for the European middle distillate and gasoline contracts.
Refinery margins held profitable through July due to a combination of weak crude oil prices and strong product cracks. This was partly in line with our expectation that they would hold from weak crude prices only. For the first time in a while we saw prompt refinery hedging in both Europe and the East, indicating refineries are keen to lock in the remainder of their cracks at elevated levels as prompt pricing expectations begin to look underwhelming.
WEAK ASIAN MARKET
A revision down in OSPs at the beginning of July signaled a slow down in the Asian market. This came into fruition just as the month began as the physical struggled to clear at discounts to already-reduced OSPs. This weakness in the physical market was realized in the Dubai benchmark, which subsequently dropped. This transpired to a weak paper market, with the Brent-Dubai contract, and Dubai time spreads slipping over the course of the month. This price action was driven by a fundamentally weak underlying market but exacerbated by market participants exiting long positions in Brent-Dubai and Dubai time spreads. As we forge on into the rest of Q3, we expect the weakness to continue, and a further revision down in OSPs as physical struggles to be placed.
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 CPC refinery margin (8:2:3 Naphtha, Kerosene, Gasoil)
- Short crude structure UZH -0.33 to -1.20
- Buy put option (January 2018 put option) 0.70 to 0.4
HOW DID IT PAN OUT?
- Product cracks held with strong sell offs in crude flat price
- Crude outright contracts, time spreads and structure were under an enormous amount of pressure, correcting downwards after months of elevated disconnection from the underlying physical market