Tuesday, August 29, 2017

Crude Oil - Post Harvey




 

 

Includes: BNO, DBO, DNO, DTO, DWT, OIL, OILK, OILX, OLEM, OLO, SCO, SZO, UCO, USL, USO, USOI, UWT, WTID, WTIU
 

Summary

The bottom of the recent trading range.
Higher lows since late June.
Processing spreads remain firm because of Harvey.
Brent - WTI reflects fundamentals.
Three reasons why crude oil could eventually surprise on the upside.
Hurricane Harvey hit Corpus Christi last weekend as a Category 4 storm, and while it quickly weakened, the weather event promises to continue dumping rain on the Texas Panhandle for much of this week. The energy rich state of Texas is always susceptible to a storm at this time of the year, but Harvey was the biggest hurricane to hit the Texas coast in years and the most ferocious in the United States since 2005.
As the storm approached late last week, the price of crude oil did not rally significantly even though the API and EIA reported inventory withdrawals of 3.595 million and 3.33 million barrels respectively. However, there are signs within the market structure of the petroleum market that the downside is limited and there is upside potential in the energy commodity for the coming weeks. The price of crude oil had recovered from the lowest level since 2003 at $26.05 per barrel in February 2016 to the $50 level on nearby NYMEX futures. Last November, a production cut by OPEC made $50 a pivot point for the price of crude oil. However, in June the price slipped to lows of $42.05 as shale output from the United States continued to weigh on the fundamental equation for oil, but it quickly recovered to the pivot price during the summer months of 2017.
Most recently, crude oil has declined to the bottom end of its short term trading range, and while $50 is the top end, there are signs that oil could be heading higher over the weeks ahead.
The bottom of the recent trading range
The hurricane in Texas is causing refinery demand for raw crude oil in the region affected by the storm to grind to a halt, and the price has declined despite a weak dollar and rising industrial commodities prices. Copper rose to a new high at $3.0870 on Monday, August 28, iron ore remained over $75 per ton, and the Baltic Dry Index was just over the 1200 level. Even the price of lumber rebounded to over the $380 per 1,000 board feet level, but oil moved to the downside. Source: CQG

As the daily chart of nearby October NYMEX crude oil futures highlights, the price put in a bearish key reversal trading pattern on August 28 and was trading at the $46.60 level close to the lows of the session at $46.15 per barrel. Short-term technical support for the energy commodity stands at $45.58 the July 24 lows. Meanwhile, the dollar index fell to a new low at 92.14 on the September futures contract as the euro currency traded to just under the 1.20 level against the U.S. dollar. Almost all commodities posted gains on Monday. Crude oil was the lonely loser in the asset class.
Higher lows since late June
The price of October NYMEX oil futures will need to hold the $45.58 per barrel level to keep the pattern of higher lows in place. Since the $42.05 lows on June 21, oil has been making higher lows and reached a high of $50.51 on October futures on the first day of August, and technical resistance remains at that level.
While the price action in the crude oil market has been bearish, there are signs in the energy sector that the downside has become limited. Products prices have rallied, and the premium for Brent crude has moved to a multi-year high over recent sessions.
Processing spreads remain firm
Processing or crack spreads exploded higher in the aftermath of Hurricane Harvey. The storm in Texas has caused many refinery shutdowns, and the prices of gasoline and heating oil futures have reacted by moving higher at a time when the price of raw crude oil is going in the opposite direction. While there is plenty of crude oil around, it is likely that inventories of gasoline and distillates will decline dramatically as a result of the storm and unprecedented flooding that followed. In Houston, weather forecasters have projected that 30-50 inches of rain will fall before the storm ends later this week. With crude oil moving lower and products higher, crack spreads exploded higher on Monday, August 28. 

  Source: CQG
As the daily chart of the October gasoline processing spread shows, the price has moved to highs of $20.58 on August 28 and was trading around the $20 per barrel level at the end of the session.

Source: CQG

Meanwhile, the price of the October heating oil crack spread which is a proxy for other distillates like diesel and jet fuels has rallied to a high of $22.46 per barrel and was above the $22 per barrel level at the end of the day on Monday.
The rise in the prices of oil products at a time when raw crude oil was going the other way is the result of refinery shut downs in Texas. However, as inventories of products will certainly decline over the coming weeks, the demand for crude oil is likely to rise when refineries come back on line shortly. Rising crack spreads tend to translate to an eventual increase in demand for crude oil.
Brent-WTI reflects fundamentals
Over recent weeks, we have seen the spread between Brent and West Texas Intermediate crude oil widen to a multi-year high. 

Source: CQG

As the weekly chart of Brent minus WTI crude oil shows, the premium for Brent rose to a high of $5.62 on August 28. The last time the Brent premium was this high was two years ago in August 2015. Brent has increased compared to the NYMEX WTI crude oil because of a combination of OPEC production cuts and increasing output from U.S. shale producers. At the same time, U.S. inventories have been on the decline over recent weeks; both the API and EIA reported declines of over three million barrels last week as of the end of the week on August 11. Last Friday, Baker Hughes reported that the number of rigs in operation dropped by five during the weeks ending on August 18.
The Brent-WTI spread has been reflecting the fundamentals of a drop in OPEC production and increasing shale output. However, lower inventory numbers in the U.S. and increasing demand for industrial raw materials from copper to steel over recent weeks is a sign that China has been buying commodities. The world’s most influential raw materials consumer is likely also increasing their petroleum reserve, and that could be putting additional upside pressure on the price of Brent crude oil. Brent is the benchmark pricing mechanism for two-thirds of the world’s oil.
Three reasons why crude oil could surprise on the upside
The knee jerk reaction of crude oil to the storm of epic proportions hitting Texas was to move lower. However, there are some signs that the selloff is currently creating a golden buying opportunity when it comes to the energy commodity. Processing spreads have exploded higher as refining has experienced interruptions. Brent has moved to a two-year high against WTI crude oil. The moves in these spreads are not necessarily bearish for the price of raw crude oil. There are currently at least three reasons why I believe the price of crude oil is a scale down buying opportunity at this time and the price could recover dramatically to the upside over coming sessions.
First, the dollar is quickly approaching its critical technical support level at 91.88 on the dollar index futures contract. 

Source: CQG

The weekly chart of the dollar index illustrates that the greenback has declined to a low of 92.13 on August 28 just 0.25 above the support level that could end the bull market in the U.S. currency that began in May 2014. A weakening dollar tends to support commodities price and crude oil is no exception.
The second reason is that while Hurricane Harvey initially supported product prices, 22% of offshore oil is currently offline because of the storm. The Eagle Ford Shale extends from South to South-west Texas and it is likely that there will be production issues for many weeks to come because of the storm. Manpower and other resources are likely to be limited as many workers will be dealing with the aftermath of the storm. Additionally, on Monday an oil rig broke away from its mooring in the Port of Corpus Christi sinking a tug boat and causing the port to close. The storm’s initial impact on refining caused product prices to explode higher but the longer-term effects are likely to cause production to slow in the oil rich state.
Finally, and perhaps most importantly, other commodities prices are moving to the upside over recent sessions. Copper, which tends to be a leader in the commodities sector, is trading at the highest price since 2014. Crude oil hit its February 2016 lows just one month after copper found a bottom at $1.9355 in January. Copper is not the only raw material moving to the upside and it may not be long before crude oil finds a bottom and begins to recover back to the $50 per barrel level, or higher in the days and weeks ahead.
I am a scale down buyer of crude oil on any further weakness in the market. While Hurricane Harvey has initially caused the price of oil to move to the downside, the medium-term effects of the storm could be very bullish for the price of petroleum.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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