Bearish Macro Backdrop Sends Oil Prices Lower

2018 was largely the year of the bull market that wasn't. As the Trump administration planned sanctions on Iran's oil prices rose from $70 in January to $86 in October. Then, the White House reversed course by issuing 'waivers' to major buyers of Iranian oil and the market ended the year near $52. Hedge funds, meanwhile, were buying the KoolAid all along and accumulated their biggest-ever long position in ICE Brent futures and options only to have to cut that position by 78% as prices fell.

Apparently traders are a little bit less gullible in 2019 as markets are consumed by fears of weak global demand growth opposite sustained production growth in the US. This new attitude really came to life last week as the largest-ever intra-day rally in the oil market was met by selling from speculators.

To back up for a moment, on the weekend of September 14th Iran-backed Yemeni rebels executed a massive drone strike on Saudi oil production which knocked out more than 5.5m bpd of production. When traders came to work on Sunday night they sent prices skyrocketing from the close of $60 on the previous Friday to $72 on the week's opening print. It was a truly unique event in the market and something that even the longest-tenured oil traders had never seen before.

One would think that a historic upward shift in prices might be met by net buying from speculators as short losing short positions are covered and new buyers come in to ride the momentum. We certainly thought that- prior to seeing this week's COT data- that the historic $12 intra-day rally would have to have been 'bought' by the managed money in the market. However, just the opposite was true. Speculators were net-short ICE Brent futures and options to the tune of 9,000 contracts (3% of total net length) for the week ended September 17th as new short positions increased slightly and long positions were reduced. We have to wonder- if the greatest oil production disruption in recent memory and largest upward price action in the history of the market can't entice buyers in the current environment, what can?

So far hedge funds have been vindicated in last week's strategy as crude prices fell from the Sunday open through Tuesday night. In Saudi Arabia officials from Aramco stated that exports would not be disrupted by the attacks (by tapping reserves and slowing their won refining) and even predicted their production would make a full recovery by the end of October (dismissed by some as overly optimistic.) Prompt Brent spreads have also weakened in the last few trading sessions but, importantly, are still trading sharply in backwardation suggesting that crude supplies are expected to be tight for at least the next few weeks.

On the macro side Trump's Twitter feed added to the bearish pressure by attacking China on trade and geopolitical strife in the US- where Democrats began and impeachment inquiry on President Trump- and Britain- where the high court ruled against Boris Johnson's suspension of Parliament- also helped push crude oil and stocks lower while government bonds rallied. As the dust continued to settle, Brent was trading back towards the $62 mark- just $2 above where it started before the attacks on Saudi production. For now, hedge funds seem wise for not being fooled twice.

Quick Hits

- Crude oil prices fell back to earth this week with Brent trading at $61 while WTI was near $56. By Tuesday headlines were once again focused on stalling global demand growth and the US/China trade war. With the Saudi production outage rally nearly erased, it was almost as if one of the most extraordinary events in recent oil market history was rendered meaningless by the bearish macro backdrop.

- Last week we noted the unusual options market structure that calls were trading at an implied volatility premium to put options as traders weighed the effects of the Saudi oil outage. This week that call-premium was erased as options traders rapidly flipped back to focusing on downside risk.

- Hedge funds sold last week's Saudi oil production outage to the tune of 9,000 contracts- about 3% of outstanding net length. We're still nearly in shock that speculators had the guts to sell the largest intra-day price rally in oil market history, but they've certainly been vindicated by recent price action. The moral of the story to us here is that speculators have been burned on the long side of the market too many times and are extremely skeptical of upside price risk under current macro-economic circumstances.

- While flat price has only moved lower since last week's attack, spread markets are telling a more bullish story about oil fundamentals. The prompt 1-month Brent spread traded near $1.00 backwardated this week telling us that the largest physical traders in the market see tight supplies in the near term.

- There were two critical geopolitical events in markets this week and they didn't occur in the Middle East. In Britain the Supreme Court ruled that Boris Johnson's recent Suspension of Parliament was unlawful. In the US the Democrats opened a formal impeachment inquiry of Donald Trump. We've normally found the various Trump White House and Brexit drama to be mere noise as markets are concerned, but these two events seem to represent a darker shift in terms of their ability to darken the macro picture. There was an obvious correlation between impeachment proceedings and a risk-off move in US equities on Tuesday.

- Speaking of risk-off, investors poured into US government bonds this week sending the US 10yr yield back towards 1.60%.

DOE Wrap Up

- US crude stocks added 1.1m bpd last week serving as a counterbalance to the bullish euphoria in the market. US crude stocks stand at 417.1m bbls and are higher by 5% y/y over the last four-week period despite having drawn down by almost 80m bbls since early June.

- Inventories in the Cushing, OK delivery hub continued to drop moving lower by 650k bbls to 38.7m- their lowest mark since December of 2018.

- The US currently has 24.2 days of crude oil supply on hand which is higher y/y by 8%.

- Domestic crude production was steady at 12.4m bpd and is averaging 12.1m bpd so far in 2019.

- US refiner demand fell nearly 800k bpd last week as facilities begin to switch capacity from gasoline to distillate fuels. The peak ten-week period of summer driving season in the US saw refiner demand that was lower y/y by 240k bpd. Demand has averaged 16.76m bpd so far in 2019 which is lower y/y by 1.5%.

- US crude imports moved higher by 300k bpd to 7m bpd last week while exports moved lower by 100k bpd to 3.2m bpd.

- US gasoline stocks rose by 780k bbls last week to 229.7m and are lower y/y by 1% over the last month.

- Domestic gasoline demand plus exports fell a whopping 800k bpd last week to 9.6m bpd. Implied demand is lower y/y by 60k bpd over the last four week period.

- The US currently has 24.1 days of gasoline supply on hand which is flat y/y.

- Meanwhile, distillate inventories increased by 440k bbls to 137m and are flat y/y over the last four weeks.