RBC Capital's take on the oil market - Dec 9
Posted: Fri Dec 09, 2022 3:12 pm
Oil Market in 60 Seconds: Our Thoughts on the Week of Disarray
Themes and Sentiment from Investor Conversations
WTI prices have fallen by $10 over the past week. We were on the road for much of that time.
Marketing during periods of significant market volatility is no fun, but it makes for ultra engaging
dialogue. Below are several central themes that featured in our discussions this week:
The oil market retracement is, in our opinion, a function of paper markets selling into low liquidity
air pockets rather than indication of a distressed physical market. Atlantic Basin differentials,
which we deem as the global marginal barrels, are far from strong, but physical barrels are not
indicating signs of fire sale, either. Crack spreads were one of the few stand out bright spots in
the oil complex over recent months and once that market buckled, paper traders began to peel
out of the oil trade.
We have been cautioning on downside risk to the NYMEX heating oil crack. Why? Because it
simply did not need to price as high anymore. Distillate inventories in the US Central Atlantic, or
PADD 1B, are low, but European Gasoil cracks have rolled over. As such, US cracks no longer have
to price as high to compete for cargoes from Europe. European demand and supply are looser
than the market previously anticipated. A warm start to winter and softer European natural gas
prices are only half the story. Rising Chinese product exports are pushing more Middle Eastern
product into the Mediterranean and Western Europe. Softer demand and increased supply
equate to soft Euro gasoil cracks, for now. If this turns, so will diesel cracks, on both sides of the
Atlantic. Until then, the re-rating likely still has room to run, lower.
We had several inbounds from clients citing rising ‘oil in transit’. This metric is a real
time measure that Vortexa provides to quantify the amount of oil en route for delivery. This
measure spiked by 77.6 mb, or 7%, WoW. While investors may be spooked that, this may serve as
a leading indicator for rising floating storage (read: contango = unsold inventory?), we caution
that such a view may be premature, at least for now. Russian crude exports for November
increased by 20% vs the previous three months, many barrels marked for Asia, ahead of Europe’s
ban on Russian oil. To this point, global floating storage, particularly in Asia, has not increased
The bear view is that the rise in oil in transit ends up with no buyers and evolves into
floating storage. Our retort to this view, again, at least for now, is that global tanker rates have
plunged over recent weeks (Figure 6). This is a signal that longer-term shipping contracts are not
being inked and that a significant number of ships will free up post discharge, rather than
earmarked for long-term floating storage. Additionally, Russia plans to move as much crude as
possible using the recently bolstered organic shadow tanker fleet to circumvent price caps,
meaning that demand for the global fleet is likely to continue easing. Rising floating storage would
suggest the opposite for freight rates.
The WCS differential, which blew out earlier this fall, suffered another setback given the Keystone
pipeline leak near Kansas, which stifles the ability for crude flow into Cushing and the US Gulf
Coast refining center. To be clear, the multiple headwinds facing Canadian heavies are a function
of different drivers. The initial cause of the widening differential was due to poor naptha content
and increased price on price competition for heavies in the Gulf Coast as a function of Colombian
barrels pushed from China and into the Gulf Coast. This week’s issue is a familiar one: Egress.
Net-net, this development is clearly negative for WCS and barrels at Hardisty, AB, while constructive
for Gulf heavies and Cushing inventories. Despite yesterday’s soft tape, WTI timespreads firmed
on the session. Robert Kwan, our Canadian energy infrastructure analyst, notes that previous spill
induced outages (Nov’17, Feb 19, Oct’19) are typically rectified in about two weeks. This outage
may prove longer given that it involves a spill into a creek. < I asked Don Simmons about this and he does not expect the Keystone pipeline outage to impact the oil price that Hemisphere receives unless the pipeline is shut down for over a month. InPlay sells all of their light oil into local refining market.
We have long suggested that lack of liquidity has been the biggest theme in the oil market of late,
contributing to the massive volatility. Spot WTI volumes traded have fallen some 40% from
normal levels over the past few months. We see this as a function of policy paralysis given most
of the primary oil market drivers have been policy based rather than fundamentally driven. Many
commodity traders have wound down risk leading into year-end. Some have been de-grossing for
weeks now, which helps to explain why managed money length in WTI is currently near levels
similar to when WTI went negative during the early days of the pandemic. Our synopsis of the
past several weeks? Paper selling into low liquidity air pockets.
Themes and Sentiment from Investor Conversations
WTI prices have fallen by $10 over the past week. We were on the road for much of that time.
Marketing during periods of significant market volatility is no fun, but it makes for ultra engaging
dialogue. Below are several central themes that featured in our discussions this week:
The oil market retracement is, in our opinion, a function of paper markets selling into low liquidity
air pockets rather than indication of a distressed physical market. Atlantic Basin differentials,
which we deem as the global marginal barrels, are far from strong, but physical barrels are not
indicating signs of fire sale, either. Crack spreads were one of the few stand out bright spots in
the oil complex over recent months and once that market buckled, paper traders began to peel
out of the oil trade.
We have been cautioning on downside risk to the NYMEX heating oil crack. Why? Because it
simply did not need to price as high anymore. Distillate inventories in the US Central Atlantic, or
PADD 1B, are low, but European Gasoil cracks have rolled over. As such, US cracks no longer have
to price as high to compete for cargoes from Europe. European demand and supply are looser
than the market previously anticipated. A warm start to winter and softer European natural gas
prices are only half the story. Rising Chinese product exports are pushing more Middle Eastern
product into the Mediterranean and Western Europe. Softer demand and increased supply
equate to soft Euro gasoil cracks, for now. If this turns, so will diesel cracks, on both sides of the
Atlantic. Until then, the re-rating likely still has room to run, lower.
We had several inbounds from clients citing rising ‘oil in transit’. This metric is a real
time measure that Vortexa provides to quantify the amount of oil en route for delivery. This
measure spiked by 77.6 mb, or 7%, WoW. While investors may be spooked that, this may serve as
a leading indicator for rising floating storage (read: contango = unsold inventory?), we caution
that such a view may be premature, at least for now. Russian crude exports for November
increased by 20% vs the previous three months, many barrels marked for Asia, ahead of Europe’s
ban on Russian oil. To this point, global floating storage, particularly in Asia, has not increased
The bear view is that the rise in oil in transit ends up with no buyers and evolves into
floating storage. Our retort to this view, again, at least for now, is that global tanker rates have
plunged over recent weeks (Figure 6). This is a signal that longer-term shipping contracts are not
being inked and that a significant number of ships will free up post discharge, rather than
earmarked for long-term floating storage. Additionally, Russia plans to move as much crude as
possible using the recently bolstered organic shadow tanker fleet to circumvent price caps,
meaning that demand for the global fleet is likely to continue easing. Rising floating storage would
suggest the opposite for freight rates.
The WCS differential, which blew out earlier this fall, suffered another setback given the Keystone
pipeline leak near Kansas, which stifles the ability for crude flow into Cushing and the US Gulf
Coast refining center. To be clear, the multiple headwinds facing Canadian heavies are a function
of different drivers. The initial cause of the widening differential was due to poor naptha content
and increased price on price competition for heavies in the Gulf Coast as a function of Colombian
barrels pushed from China and into the Gulf Coast. This week’s issue is a familiar one: Egress.
Net-net, this development is clearly negative for WCS and barrels at Hardisty, AB, while constructive
for Gulf heavies and Cushing inventories. Despite yesterday’s soft tape, WTI timespreads firmed
on the session. Robert Kwan, our Canadian energy infrastructure analyst, notes that previous spill
induced outages (Nov’17, Feb 19, Oct’19) are typically rectified in about two weeks. This outage
may prove longer given that it involves a spill into a creek. < I asked Don Simmons about this and he does not expect the Keystone pipeline outage to impact the oil price that Hemisphere receives unless the pipeline is shut down for over a month. InPlay sells all of their light oil into local refining market.
We have long suggested that lack of liquidity has been the biggest theme in the oil market of late,
contributing to the massive volatility. Spot WTI volumes traded have fallen some 40% from
normal levels over the past few months. We see this as a function of policy paralysis given most
of the primary oil market drivers have been policy based rather than fundamentally driven. Many
commodity traders have wound down risk leading into year-end. Some have been de-grossing for
weeks now, which helps to explain why managed money length in WTI is currently near levels
similar to when WTI went negative during the early days of the pandemic. Our synopsis of the
past several weeks? Paper selling into low liquidity air pockets.