Energy Market Analysis – Thursday Morning, April 17, 2014

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Quote of the Day
In family life, love is the oil that eases friction, the cement that binds closer together, and the music that brings harmony. – Eva Burrows

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The main issue keeping oil prices near the highs of the two week or so uptrend continues to be the evolving situation in the Ukraine and the concern that an escalation could potentially disrupt oil supplies from Russia. Overnight the media is reporting at least three pro-Russian militants were killed, at least thirteen wounded and 63 were arrested in a confrontation at a military base in the east of the country. Tensions are rising.

Today diplomats from the Ukraine, the US, the EU and Russia are meeting in Geneva to try to de-escalate the situation using diplomatic means. US officials said a full-scale Russian invasion of eastern Ukraine would result in broad U.S. and European sanctions on key Russian economic sectors, including the energy industry. However, European nations are divided on whether to limit its access to Russia’s oil and gas supplies, and a vote to sanction must be unanimous among the EU’s 28 member states. Until this situation is diffused oil prices and Nat Gas prices in Europe will remain firm especially heading into the long holiday weekend.

Absent the Ukraine oil prices would likely be lower as overall oil fundamentals are basically bearish as the crude surplus in the US continues to grow while global demand may be waning.

The geopolitical risk emanating from the Ukraine is also impacting the Brent/WTI spread. The spread has staged a modest recovery so far this week after hitting a low on April 11th. The broader, longer term trend is still toward a return to normalcy. That said with Ukraine situation is impacting the Brent side of the spread while the spring refinery maintenance season is having an impact on the WTI side of the spread. The road to normalcy is going to be choppy over the next month or so.

The following two charts (updated with the latest inventory data release) continue to highlight what has been happening. The first chart shows current Cushing crude oil inventory data compared to its five year average as well as the highest and lowest levels hit during the last five years for each individual week  In addition I have included what I call the pre-surplus five year average for the period 2004 through 2009. This average inventory level was approximately 21.7 million barrels over the aforementioned period.

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As shown on the chart crude oil stocks in Cushing have resumed its destocking trend that has been in play for the vast majority of this year with the level well below the current five year average as well as the minimum level over the last five years for the same week. Inventories are heading toward the so called normal pre-surplus level as the industry moves stocks to normal operating levels required by the refining and logistics sectors.

Crude oil stocks in Cushing are now only about 5.1 million barrels above the pre-surplus inventory average. With the WTI forward curve still in a relatively steep backwardation the rate of destocking in Cushing is likely to continue at the rate of decline it has been running at over the last few months. If so current inventory levels should hit the pre-surplus level within the next several months.

As the Cushing overhang continues to recede it has a direct impact on the pricing relationship between Brent and WTI. The following chart shows the current path of the spot Brent/WTI spread compared to its current five year average as well as the average trading level during the pre-surplus five year average for the period 2004 through 2009. Over the 2004 through 2009 period the Brent/WTI spread averaged a $0.79/bbl discount of Brent below WTI. As of this writing the spot spread is trading around a $6.30/bbl premium of Brent over WTI and has reversed to a widening trend for the reasons discussed above after narrowing for most of the year. The narrowing tend will resume.

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Several factors continue to support my view of the spread returning to a more normal historical trading relationship (what I refer to as the 2004-2009 average). The main drivers keeping the spread in a narrowing pattern are:

The WTI forward curve still in a relatively steep backwardation while Brent is starting to move into a slight contango in the front end of the curve.

  • The outflow capacity out of Cushing is continuing to increase as the Keystone Gulf Coast pipeline works its way to its design capacity while the Seaway Twin pipeline readies for start-up toward the second half of May or early June.
  • Global oil demand seems to be easing especially in China and Europe which will impact the Brent side of the spread.
  • The completion of the US spring refinery maintenance season will result in an increase in crude oil demand.
  • The potential return of Libyan oil production in the short term as discussed above will also have a more direct impact on the Brent side of the spread.

This week’s oil fundamental snapshot was biased to the bearish side with total crude oil and refined products inventories surging higher as crude oil stocks increased in the US and in PADD 3. With another above normal build in crude oil stocks in this week’s report the main focus continues to be the big shift that is well underway in crude oil supply between PADD 2/Cushing and PADD 3 (Gulf Region).

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The movement of crude oil from the mid-continent has been accelerating as the pumping rate of the newly commissioned Keystone Gulf Coast Pipeline continues to slowly work its way toward design capacity of 700,000 bpd. This week’s EIA inventory report showed a small draw in crude oil stocks from the broader PADD 2 (0.1 million barrels) region as well as in Cushing of about 0.8 million barrels while PADD 3 crude oil inventories increased by 5.2 million barrels.

The shift of crude oil from PADD 2 and Cushing showing up in the Gulf region will result in inventories continuing to build further as the refining sector progresses into the maintenance season. The maintenance season is only starting to impact the Gulf as refinery run rates in PADD 3 are still hovering near the 90 percent utilization level. The movement of crude oil to the Gulf is certainly beginning to impact all of the pricing interrelationships of both US and international crude oil grades as well as refined product markets. For example the LLS/WTI spread is still trading well below the $3/bbl level making spot movement of light Bakken crude oil by rail uneconomical.

Total commercial stocks of crude oil and refined products increased by 14.4 million barrels. The year over year deficit narrowed strongly to 28.9 million barrels while the deficit versus the five year average for the same week narrowed to 14.2 million barrels.

Crude oil inventories increased as crude oil imports increased strongly last week (the increase in crude imports was mostly in PADD 5 or the West Coast). Total crude stocks built by 10 million barrels. With the increase in crude oil stocks this week the crude oil inventory status versus last year is showing a surplus of 6.5 million barrels while the surplus versus the five year average for the same week came in around 26.8 million barrels.

PADD 2 crude oil inventories decreased slightly  by about 0.1 million barrels while Cushing, Ok crude oil inventories also decreased by about 0.8 million barrels. PADD 2 crude oil stocks are now showing a deficit of 19.4 million barrels versus last year with a 2.2 million barrel deficit versus the five year average. The Cushing area deficit came in at 24.3 million barrels versus last year with a 12.3 million barrel deficit compared to the five year average.

PADD 3 crude oil stocks surged by 5.2 million barrels as crude oil imports into PADD 3 increased modestly.  PADD 3 crude oil stocks are now showing a surplus of 22.2 million barrels versus last year with a 24.3 million barrel surplus versus the five year average. PADD 3 crude oil stocks set yet another new record high as shown in the following chart. Based on EIA reported shell capacity in PADD 3 crude oil inventory are at about the 90 percent utilization level.

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Distillate stocks decreased by 1.3 million barrels and within the market expectations even as total US refinery run rates increased to 88.8 percent of capacity. The year over year comparison shows current stock levels at about 3.3 million barrels below last year. The five year average deficit came in around 24.4 million barrels.

Gasoline inventories decreased less than the expectations. Total gasoline stocks decreased by about 0.1 million barrels on the week as the industry continues the transition from winter grade gasoline. The deficit versus last year came in around 11.4 million barrels while the deficit versus the five year average for the same week came in at about 6.3 million barrels.

Gasoline stocks increased modestly by 0.3 million barrels in PADD 1 (US East Coast) this week with the deficit versus last year coming in around 5.8 million barrels with a 1.8 million barrel deficit compared to the five year average for the same week.

The following table details the week to week changes for each of the major oil commodities at every level of the supply chain. As shown I have presented a mixed categorization on the week for the complex. However, this week’s report was biased to the bearish side.

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I am maintaining my oil view at neutral and my bias at neutral as the market digest the evolving situation in the Ukraine while awaiting news of Libyan oil possibly flowing once again. I continue to suggest that you remain cautious on Libya until oil is consistently flowing once again.

I am maintaining my Nat Gas view at neutral and my bias at neutral as the market moved back into a higher trading range ahead of the upcoming lower demand shoulder season. The Nat Gas spot Nymex contract remains in the $4.30/mmbtu to $4.70/mmbtu trading range.

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Markets are mostly higher heading into the US trading session as shown in the following table.

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Best Regards,

Dominick A. Chirichella

dchirichella@mailaec.com

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Energy Market Analysis is published daily by the Energy Management Institute, 1324 Lexington Avenue, #322, New York, NY 10128. Copyright 2009. Reproduction without permission is strictly prohibited.

Editor in Chief: Dominick A. Chirichella, Publisher: Stephen Gloyd, Editor: Sal Umek. Information and opinions expressed in this publication are intended to provide general market awareness. The Energy Management Institute and the Energy Market Analysis are not responsible for any business actions, market transactions, or decisions made by its readers based on information published in this report. Readers of the Energy Market Analysis use this market information at their own risk.

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