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Why Are Oil Markets Ignoring All These Bullish Signs?

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- Crude oil’s drop back into the high $40s has renewed concerns that efficiency gains from North American frackers will lead to another low/mid $40s scenario for WTI. We feel that an extended drop of this nature is unlikely given the progress that OPEC cuts have made in normalizing crude oil and refined product inventories in Asia and Europe and think that the same progress will move west as refiners ramp up to make summer gasoline for a broadly strong US economy. In terms of focus, our view is that that the market is preoccupied with US data in pushing a short term bearish narrative while discounting the bullish progress occurring overseas where data is less visible and less potent in its short term market impact.

- To assess OPEC progress overseas we are pointing to Japan’s crude stocks which were lower y/y by 6% in January and refined products that were lower by 9%. In Europe, ARA crude oil stocks are lower y/y by 2% YTD while gasoil stocks are down by a whopping 13%. Further east, Singapore distillate stocks + SE Asia floating product stocks are lower by 5% y/y over the last five weeks and China’s crude oil + refined products in floating storage are -7% YTD. Even in the lagging US, USGC gasoline stocks (the world’s largest gasoline storage hub) are -3% y/y over the same period. To be fair, these numbers don’t scream “$60 oil!” to us, but they should mitigate downside risk opposite reasonably strong demand gains.

- As for the demand side we also believe that the market has been overly focused on US data which has lagged global data. US refiner demand and gasoline demand are both roughly flat so far in 2017. This trend is inconsistent with currently positive US economic data and we expect to see a convergence between crude oil demand data and economic growth data over the course of the year. SocGen and the IEA are still calling for global demand growth of roughly 1.4m bpd in 2017 which- if realized- would be forceful partner to OPEC in normalizing crude oil inventories. Energy Aspects also increased their diesel demand forecast for 2017 this week from 500k bpd of y/y growth to 600k bpd with help from robust Asian and LatAm demand growth.

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WTI spreads in a Syncrude / Midland tug of war

WTI spreads fell sharply this week on a US inventory build of 5m bbls (US crude stocks now +6% y/y) and a Cushing build of 1.4m bbls which brought inventories in the hub to 68m bbls. There also seemed to be a tug of war on WTI fundamentals with a stubbornly strong Syncrude diff and an extremely weak Midland-WTI market. As of now, Midland-WTI dynamics (i.e. low exports, saturated PADD III stocks) are clearly in control of WTI sentiment but we’re looking for Syncrude’s curiously strong +3.60 print on Thursday (taking out last week’s fire-induced high) to lend support to WTI spreads in the coming weeks.

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The end result of the aforementioned stress on WTI spreads was a 2-month low in K17/M17 at -0.60 before a small bounce on Thursday to -0.55. Betweem growing PADD II stocks, growing PADD III stocks and growing Cushing stocks it’s been a painfully bearish ride for WTI spreads and even pockets of strength such as elevated Syncrude-WTI look vulnerable to Canadian output growth to +4.05m bpd which is leading to increased PADD II imports of 2.7m bpd. In option markets we saw several different types of players expressing bearish views on WTI spreads this week bidding -25, -50 and -100 puts in K17-Z17.

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Brent spreads moved sharply higher this week through Thursday despite the reopening of key exporting facilities in Libya which allowed a production jump from 620k bpd last week to 700k bpd this week. As of Thursday Brent K17/M17 traded -10 cents for a 20-cent rally over 48hrs while Dated vs. Front Line Brent was flat near -65. Our read of market sentiment suggests that traders remain mostly positive on brent spreads and expect a high level of production cut compliance to drive spreads towards backwardation in the coming months.

Brent spreads moved sharply higher this week through Thursday despite the reopening of key exporting facilities in Libya which allowed a production jump from 620k bpd last week to 700k bpd this week. As of Thursday Brent K17/M17 traded -10 cents for a 20-cent rally over 48hrs while Dated vs. Front Line Brent was flat near -65. Our read of market sentiment suggests that traders remain mostly positive on brent spreads and expect a high level of production cut compliance to drive spreads towards backwardation in the coming months.

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Hedging and bearish fears keep maintain the put-bid

The crude option smile maintained a bearish shape this week with WTI M17 25 delta puts implying 32% volatility while 25 delta calls traded near 27.5%. The 4.5 vol premium was due to banks and producers actively buying $50, $45 and $40 downside risk in K17-Z17 while selling call options. Speculators also played their part by bidding puts early in the week in anticipation of bearish EIA data. As for the middle of the curve, Wednesday’s WTI print of $47.01 justified ATM volatility near 29%-30% with realized volatility in the 28% area. Our assumption moving forward is that option markets will stay well bid as long as underlying contracts maintain their current ‘4 handle.’ Given the positive view of flat price we laid on the first page of this report we expect to see good opportunities to sell downside risk on dips in the coming weeks.

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Refined products are tightening, but we still need more demand

- US crude stocks added 4.95m bbls this week concentrated in PADD II and Cushing
- Production continues to exceed expectations inching up to 9.13m bpd
- Gasoline and Distillate stocks fell by a combined 5m bbls and both products are now in y/y deficit
- Refiner demand remains bearishly low and is -2% y/y over the last four weeks. Domestic gasoline demand is -3% y/y and will also have to improve if crude oil is going to achieve its next leg higher

U.S crude oil inventories suffered an above-forecast inventory build this week increasing 4.95m bbls. Overall inventories are higher y/y by 6% over the last four weeks while PADD I stocks are +13%, PADD II stocks are +4% and PADD III stocks are +6.5%. Cushing stocks also jumped 1.4m bbls and at 67.95m bbls are within 325k bbls of their all-time high. Imports were a key contributor to the weekly build increased 900k bpd with a 230k bpd increase into PADD II and a 560k bpd in PADD III. Exports were also bearishly low at just 550k bpd.

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U.S refiner inputs made a solid w/w jump of 329k bpd at 15.8m bpd and will need to continue that course in order to support the market. Over the last four weeks inputs are lower y/y by 1.8% with PADD I inputs -20% y/y, PADD II inputs +2.5% y/y, PADD III inputs flat y/y and PADD V inputs -4.6% y/y. Refiner utilization printed 87.4% and is lower by 2.6% y/y over the last month. Refining margins generally crept higher this week with the WTI 321 crack yielding $18/bbl while RBOB/Brent traded just shy of $17/bbl. Overseas margins included gasoil/brent trading $9.90/bbl.

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Gasoline markets enjoyed another expectation-beating draw this week falling 2.8m bbls. The main driver of the decline was another weekly drop in imports into the US east coast as tankers have moved to avoid the saturated market. However, several gasoline analysts have suggested that this trend could reverse in the coming months. Overall stocks are now lower y/y by 0.7% with PADD I stocks +2% y/y, PADD II stocks +1.4% y/y and PADD III stocks -1% y/y. PADD IB stocks fell by more nearly 2.5m bbls w/w and into a modest y/y deficit for the first time in 2017. Domestic gasoline remains bearish and at 9.2m bpd is lower by 3% y/y.

Distillate data also continued to beat expectations this week with solid demand numbers and sharp draws out of the east coast. Overall supplies decreased by 1.9m bbls w/w and are now lower y/y by 4% over the last month. Regionally, PADD IB stocks fell by 1.3m bbls and are +1% y/y while PADD II stocks are -5% and PADD III stocks are -8% y/y. Domestic distillate demand fell to 4m bpd on the week by is still higher y/y by 19% v. 2016. Exports jumped to 1.2m bpd are are lower y/y by 9%.

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By SCS Commodities Corp.

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