If last night’s speeches by the potentates of the two biggest economies are used as reference points, then the world appears to be one big happy place. Despite the increasing hostilities between China and the US, Chinese Premier Li Qiang, whilst warning of challenges lying ahead, assured the audience that his country will grow at the rate of 5% with a budget deficit planned to be around 4%. After a big leap from Beijing to Washington President Trump, in his State of the Union address, remained true to his combative self. He warned everyone who listened that he was ‘just getting started’ and characterized the first six weeks of his presidency as the most successful in US history.

Maybe the sun always shines in Washington DC, but the forecast was rather cloudy in Wall Street. Major stock indices keep falling with the introduction of tariffs on Chinese, Canadian and Mexican imports as retaliatory measures are inevitable and imminent. The tech-heavy Nasdaq index has lost nearly 10% of its value since mid-December. While Mr Trump seems reluctant to change his mind on punitive measures, easing tariffs is a reasonable assumption in case of further deterioration of US equity prices.

Inauspicious economic prospects naturally weigh on oil prices and when it is coupled with the announced plan from OPEC+ to start putting barrels back into the market from April onwards the only way is down. However, it is worth mentioning that the same way as the US President might be kept under control by the stock market performance, the decision to increase oil production could easily be reversed in the absence of any meaningful price recovery in the coming weeks, limiting further downside potential.

Financial and Physical Markets are not Aligned

The words ‘uncertainty’ and ‘unpredictability’ have featured more frequently on the pages of this report in the past 6 weeks than in the preceding four years. Every topic we explore must have a caveat, with ‘ifs’, ‘maybes’ and ‘perhapses’. Below, there is an attempt to resist the temptation to speculate as to what the future might hold in the whirlwind policymaking of the US administration and a snapshot is being taken, which hopefully paints a semi-reliable picture of how investors assess the unassessable and incomprehensible, starting with the Commitments of Traders reports and then moving on to assorted price differentials.

The latest reports on the positions of money managers, producers and swap traders cover the week ending 25 February. In the ensuing days, prices drifted further south therefore the next data set due out on Friday will probably paint an even more ominous picture of investors’ sentiment. When the 5 major futures and options oil contracts traded on the CME and ICE are taken into account one observes a rather salient outflow from our beloved asset class. During the week of Mr Trump’s inauguration, $44 billion was invested in the above-mentioned contracts. By the latest reporting period, it has nearly halved and dipped below $25 billion. The price of the front-month WTI plunged $7/bbl and that of Brent slightly more than $6/bbl in these 5 weeks.

With prices on a downward spiral, it will not come as a shock that Net Speculative Length (NSL) has declined in the major crude oil futures and options contracts. The fall was much more profound in WTI than in Brent. NSL in the US crude oil benchmark dived from 236 million bbls to 39 million bbls, whilst the retreat in Brent was a mere 42 million bbls, from 263 million bbls to 221 million bbls. Brent now makes up 85% of the collective crude oil NSL. It is also noticeable that the decline in NSL was more of a function of longs positions being scaled back in Brent, whilst in WTI gross short positions have increased 70 million bbls to 158 million bbls. In other words, WTI investors have taken a much more bearish view, which runs counter to the latest developments discussed below.

The middle of the barrel shows a different picture from crude oil and echoes the persistently cold temperatures in the northern hemisphere. NSL in the CME Heating Oil contract flipped positive and has risen by 15 million bbls since January 21. Although money managers have cut back on Gasoil NSL in the past 5 weeks, it is 22 million bbls higher than at the beginning of February. Net length in the RBOB contract retreated from 51 million bbls to 28 million bbls between January 21 and February 25. Verdict: there is a cautious pessimism amongst money managers, which has not translated into unconditional bearishness yet.

The structure of the two crude oil contracts remains backwardated but the premium on the front-end narrows. M1/M2 WTI is now … cents/bbl compared to 83 cents/bbl on inauguration day. The front Brent spreads has shed more than 50% of its value as it plunged from $1.05/bbl to … cents/bbl. The same trend is observed further down the curve with the M1/M7 spreads also falling but remaining in backwardation for now. It is intriguing to observe that Brent CFDs, a reliable gauge of the health of the physical market remain bid, as the impact of the latest round of Russian sanctions introduced in January is still felt. Dated Brent for next week is priced around $.../bbl over its forward peer. Urals, both in the Med and in NWE have weakened around $3/bbl compared to European marker because of the embargo. Intriguingly, the arbitrage has not changed much since January 20, yet it is discernible that WTI keeps gaining ground over Brent in the last two weeks as the threatened and now realized tariffs on Canada and Mexico provide relative support to the US marker. Verdict: the weakness experienced in outright prices is not confirmed unambiguously in crude oil spreads.

And finally, crack spreads. The sudden jump in RBOB/WTI and the 3-2-1 crack spreads must not be taken at face value; it is the result of the spec change in RBOB after last week’s expiry. Generally speaking, crack spread values are broadly stable and imply a market that is in some kind of equilibrium. All-in-all verdict: the defensive attitude displayed by financial players is not entirely mirrored in the physical markets and the dilemma, to which it would be a bold attempt to provide a definitive answer, is whether it is the former that will align with the latter or the other way round.

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