Looking back at the performance of the past few weeks there is one salient question that needs to but cannot be answered instantly: are distillates going to sound the death knell of the current bull run or despite the violent nature of the contract(s) the move higher will continue unabated? On one hand, yesterday’s dump in Heat and Gasoil flat price is anything but promising with the Heat crack losing $4.70/bbl on the day. The plunge in distillate prices was ostensibly triggered by elevated Chinese diesel exports in August. The country’s General Administration of Customs reported a 52% rise in monthly shipments of the product. On the other hand, crude oil is clearly becoming a scarce commodity, at least this is what, apart from the ninth daily gains this month, the deepening backwardation on both WTI and Brent suggests. The front-month is now commanding a premium of nearly $7/bbl over M6 in WTI and $6/bbl in Brent, up from $1.60/bbl on August 23. Unless global middle distillates inventories start building unexpectedly in coming weeks any weakness should prove temporary.

The fundamental backdrop is price supportive, at least for now, but anxiety is the part and parcel of the current move higher. A central bank-heavy week, in which the market eagerly awaits six crucial interest rate decisions (the US on Wednesday, Sweden, Switzerland, Norway and the UK on Thursday, and Japan on Friday) will do nothing to calm nerves as the clash between considerably reduced supply and less than reassuring economic outlook continues.
 

GMT +1	Country	Today’s data	Expectation
09.00	Euro zone	Core Inflation Rate YoY August	5.3%
13.30	US	Building Permits Preliminary August	1.44 million

 

Growing Thirst for the Black Stuff

In the last few months, the bond between money managers and the oil market has gotten stronger, money has been pouring in. Whether it is the beginning of a beautiful, stable friendship or a fall-out is fast approaching is impossible to tell. The fact is that financial investors have lately been seeing attractive return potential in our segment of the market. It is unquestionably displayed in the changes of net speculative length (NSL) where the break-down in the NSL of individual components reveals an intriguing story.

To begin with the broad picture, combined amount under management (the five major oil futures & options contracts) has nearly tripled since the middle of May. For the week ending May 16, there was slightly over $22 billion invested in oil futures & options instruments. The latest data from the CFTC and ICE for the week ending September 12 has shown that nearly $65 billion have been committed to oil.

The two major crude oil contracts have been the most reliable investment vehicles of late – in other words the increase in NSL have been the most constant in WTI and Brent. Combined NSL has doubled since the middle of May, it has risen from 249 million bbls to 499 million bbls. There was a dip towards the end of June when NSL declined to 205 million bbls but the voluntary cuts in production and exports from July onwards have clearly achieved the desired effect. The increase in NSL in WTI was more of a function of a jump in gross long positions – it has increased from 232 million bbls to 306 million bbls in the last four months whilst short positions have only retreated by 36 million bbls. In Brent, the swelling of NSL was the result of both bulls adding to their exposure and bears becoming conservative. Gross long positions have been up from 202 million bbls to 288 million bbls and at the same time bets on lower prices have been reduced from 95 million bbls to 41 million bbls.

There are two curious aspects of the rise in collective crude length. The first one is the growing dominance of WTI at the expense of the European benchmark. Ironically, in June WTI did become an integral part of the Brent basket and thus a European crude marker and it is reflected in its palpable significance on the speculative front. In June its weight against Brent was hardly over 20%. As of last week, and for the first time this year, NSL in WTI has exceeded that of Brent., Secondly, the long/short ratio (again, combined WTI and Brent) has broken over 6 and is very close to matching this year’s high. Gross long positions at 593 million bbls are set against gross short positions of 94 million bbls. Last time it happened was in April and was followed by a dip of more than $10/bbl. It might be audacious to suggest a hasty correction reminiscent of the April sell-off in the light of the predicted supply deficit for the balance of the year, nonetheless, history suggests that high long/short ratio is often the canary in the coalmine.

Products have been equally in fashion in the last few months, Heating Oil and Gasoil more so than RBOB. Money managers in the middle of the barrel were actually net short back in May and the fact that they are long 35 million bbls and 6.6 million tonnes respectively is a clear indication of the developing tightness. The worrying element of the changes in NSL of these two contracts is that financial investors shed 4 million bbls of net length in Heating Oil and 2.7 million tonnes in Gasoil last week, possibly due to healthy Chinese export figures. Nonetheless, refinery maintenance and Russia’s domestic supply priorities might imply that the dearth availability of barrels in distillates will grow again as winter approaches. RBOB seems solid with investors upping net exposure by 7 million bbls last week and 32 million bbls or 80% since May.

The newly found love for oil is understandable. The oil balance promises to be tight and a cold winter north of the Equator could cause significant spike in distillate prices. At the moment there is no fundamental justification to reverse the speculative course, economic headwinds, however, might make it increasingly difficult for money managers to add to the already existing lengths, yet the backwardated nature of every major futures contract serves as an incentive to keep them.
 

Overnight Pricing