RBC Capital's view of the Oil Market - July 7
Posted: Wed Jul 07, 2021 11:32 am
RBC Capital Markets
July 6, 2021
Oil Market in 60 Seconds: Indicators Worth Watching
The medium term fundamental tightening trend remains in place given that demand growth
looks to continue to outpace supply growth over the next 12-18 months, but market
positioning may prove to be the defining factor driving price volatility over the near term. Short
covering rallies will prove to be rare events over the summer given that investor short
positioning remains among the lowest in half a decade. Most market participants agree that
dips are buying opportunities, but in order for prices to rally through $80/bbl and higher, fresh
length must put in the work required to accelerate the price appreciation.
The current deadlock to an OPEC deal has introduced a temporary degree of uncertainty for
the market, hence yesterday’s sell off, but the clarity lies in the notion that the market will
need an increasing amount of global supply to surface to prevent structurally tight inventories
and overheated pricing in the coming quarters. Normalizing inventories, tapering OPEC spare
capacity and an upcoming call on US shale, round out our long held three-step blueprint for
sustainably higher oil prices. The common theme in this roadmap centers on removing both
storage and supply buffers, leading to a structurally tight fundamentally driven cycle. While
$100 oil should not yet be a base case investment thesis, plausible pathways are within the
realm of possible for next year.
While we remain of the view that the market is in the early stages of a strong cycle, we
anticipate that the supply side of the equation dictates the price and the shape of the cycle
(price highs, lows, skewness and kurtosis), and demand will dictate the duration of the cycle.
It remains prudent practice to continue to monitor the pace of demand recovery on several
fronts. End user retail pump prices have escalated to $3.13/gal in the US, which is 5% higher
than at any point during the Trump administration, as well as refinery demand for crude given
the blow of higher crude pricing on less than inspiring global refining margins.
The rolling WTI front time spread has rallied by more than 3x over the past month. And while
spread valuations have looked stretched for weeks on a historical basis, the market continues
to refrain from bucking the trend of positioning for upside. We see WTI outperforming Brent
as a growing theme through the balance of the year. Why? Domestic US fundamentals
continue to fast forward, at an accelerated pace, relative to the rest of the world.
Stocks at Cushing are more than 10 mb below seasonally normal levels. Given Cushing storage
utilization of 52%, our historical regression model implies that the backwardation between the
WTI 1 vs 6 month contract should price near $0.90/bbl. The current spread near $4.50/bbl
implies Cushing storage levels closer to 24.3 mb rather than the EIA reporting of 40.2 mb. The
backwardation appears over valued relative to a historical basis, but crude quality can help to
justify the strong pricing. The composition of the crude quality held at Cushing tank farms has
always been a market enigma given the trading houses operating the facilities, but channel
checks suggest that WTI spec light, sweet crudes are in short supply. In other words, a shortage
of the ‘right type’ of ‘on spec’ WTI crude will support term structure and spreads.
Long time spreads also fit into the theme of momentous aggregate US crude drawdowns that
continue to push crude spreads to multiyear highs. The rapidly tightening WTI discount to
Brent is an indication that the market is attempting to price to incentivize increased imports
and keep barrels at home. US crude inventories are currently in a massive 31 mb deficit to
seasonally normal levels. The increasing chorus of calls for WTI to trade towards Brent parity
will pick up momentum throughout the summer given that US crude stocks will remain
structurally tight. Imports of US crude hit the highest levels of the year mid last month and US
crude exports also averaged near the highs of the year at 3.7 mb/d over the past three weeks
despite a rapidly tightening WTI discount to Brent (from -$4.00/bbl to current levels near -
$1.90/bbl over the past two months. In other words, rapidly eroding export economics have
yet to be able to choke off outbound shipments. As US balances continue to tighten throughout
the summer, will the market swiftly price WTI near parity to Brent to unequivocally slam the
door shut on export economics?
July 6, 2021
Oil Market in 60 Seconds: Indicators Worth Watching
The medium term fundamental tightening trend remains in place given that demand growth
looks to continue to outpace supply growth over the next 12-18 months, but market
positioning may prove to be the defining factor driving price volatility over the near term. Short
covering rallies will prove to be rare events over the summer given that investor short
positioning remains among the lowest in half a decade. Most market participants agree that
dips are buying opportunities, but in order for prices to rally through $80/bbl and higher, fresh
length must put in the work required to accelerate the price appreciation.
The current deadlock to an OPEC deal has introduced a temporary degree of uncertainty for
the market, hence yesterday’s sell off, but the clarity lies in the notion that the market will
need an increasing amount of global supply to surface to prevent structurally tight inventories
and overheated pricing in the coming quarters. Normalizing inventories, tapering OPEC spare
capacity and an upcoming call on US shale, round out our long held three-step blueprint for
sustainably higher oil prices. The common theme in this roadmap centers on removing both
storage and supply buffers, leading to a structurally tight fundamentally driven cycle. While
$100 oil should not yet be a base case investment thesis, plausible pathways are within the
realm of possible for next year.
While we remain of the view that the market is in the early stages of a strong cycle, we
anticipate that the supply side of the equation dictates the price and the shape of the cycle
(price highs, lows, skewness and kurtosis), and demand will dictate the duration of the cycle.
It remains prudent practice to continue to monitor the pace of demand recovery on several
fronts. End user retail pump prices have escalated to $3.13/gal in the US, which is 5% higher
than at any point during the Trump administration, as well as refinery demand for crude given
the blow of higher crude pricing on less than inspiring global refining margins.
The rolling WTI front time spread has rallied by more than 3x over the past month. And while
spread valuations have looked stretched for weeks on a historical basis, the market continues
to refrain from bucking the trend of positioning for upside. We see WTI outperforming Brent
as a growing theme through the balance of the year. Why? Domestic US fundamentals
continue to fast forward, at an accelerated pace, relative to the rest of the world.
Stocks at Cushing are more than 10 mb below seasonally normal levels. Given Cushing storage
utilization of 52%, our historical regression model implies that the backwardation between the
WTI 1 vs 6 month contract should price near $0.90/bbl. The current spread near $4.50/bbl
implies Cushing storage levels closer to 24.3 mb rather than the EIA reporting of 40.2 mb. The
backwardation appears over valued relative to a historical basis, but crude quality can help to
justify the strong pricing. The composition of the crude quality held at Cushing tank farms has
always been a market enigma given the trading houses operating the facilities, but channel
checks suggest that WTI spec light, sweet crudes are in short supply. In other words, a shortage
of the ‘right type’ of ‘on spec’ WTI crude will support term structure and spreads.
Long time spreads also fit into the theme of momentous aggregate US crude drawdowns that
continue to push crude spreads to multiyear highs. The rapidly tightening WTI discount to
Brent is an indication that the market is attempting to price to incentivize increased imports
and keep barrels at home. US crude inventories are currently in a massive 31 mb deficit to
seasonally normal levels. The increasing chorus of calls for WTI to trade towards Brent parity
will pick up momentum throughout the summer given that US crude stocks will remain
structurally tight. Imports of US crude hit the highest levels of the year mid last month and US
crude exports also averaged near the highs of the year at 3.7 mb/d over the past three weeks
despite a rapidly tightening WTI discount to Brent (from -$4.00/bbl to current levels near -
$1.90/bbl over the past two months. In other words, rapidly eroding export economics have
yet to be able to choke off outbound shipments. As US balances continue to tighten throughout
the summer, will the market swiftly price WTI near parity to Brent to unequivocally slam the
door shut on export economics?