Scraping the barrel
A new dawn or merely a false start for oil?
The darkest hour is typically just before dawn, and nothing could be closer to the truth when it comes to oil prices.
Oil prices continued to surge overnight as the remarkable recovery unfolds before the market’s eyes; prices are on the mend from the darkest hour of April 21 when US oil plunged into negative territory, sending investors to their beam ends while threatening to sink the industry as a whole.
Lower prices have led to much quicker than expected organic and voluntary curtailments in the US markets, to the extent that it now appears likely US oil has cleared its primary hurdle on storage capacity issues. As such, the contangos are flattening as traders move in on weakness, buying Brent time spreads to hopefully capture the eventual shift of the forward curve into backwardation. The evaporation of the super contango in WTI reduces the costs of the contract roll and should bring more participation to the markets. The curve flattening also makes a massive difference for cross-asset trader sentiment.
Indeed, Genscape reported a 1.8 million-barrel build in inventories in Cushing, Oklahoma, the delivery point for West Texas Intermediate crude. If the EIA data indicates a similar number Wednesday, it will mark the smallest increase at the hub since mid-March and should nudge the market rally along nicely.
With the April oil collapse but a distant memory, oil prices continue to rally, with OPEC+ production cuts taking effect and several major producers responding to the challenging economic conditions with production curtailments. In the US, Exxon, Chevron and ConocoPhillips have announced planned collective production curtailments totaling 660kb/d, a combination of voluntary cuts in response to low oil prices and compliance with requests from host governments to reduce production in line with the OPEC+ agreement.
Also helping to support oil prices is evidence we’re through the worst of the global oil demand downturn. Indeed, with economies reopening around the world and the market rebalancing in full swing, traders are positioning for a multi-staged pickup in demand, initially led by gasoline demand at the pump as consumers emerge from lockdowns.
Using the China blueprint, there’s unambiguous evidence of traffic coming back to China's big cities; according to TomTom, recent road traffic data in Beijing and Shenzhen have shown that rush-hour congestion is busier than pre-coronavirus levels. So, one could extrapolate similar tendencies to occur throughout the world as people shun the mass transit system in favor of private transportation, which should be excellent for gasoline demand.
But it’s not a case of throwing all caution to the winds as macro data over the remainder of 2Q might limit the upside for oil and could even trigger renewed selling pressure if the pent-up consumer demand is less than expected.
According to UBS, the largest oil-tracking ETF, quoted to account for a quarter of total most-actively traded WTI contracts before the sub-zero oil print, has halted creations for the last couple weeks while reviewing its methodology. But this has not stopped investors piling into other oil tracking ETFs, predominantly crude oil, which has received $1 bn in the last five days (a 20% increase in assets) and $3.5 bn in the previous month (more than doubling assets). On the surface this appears bullish for oil markets.
But my question is this: Are these inflows directional longs or creations to lend to market participants to short?
This is a prevalent institutional trade where The Short Interest % Estimate (the estimate of shares sold short as % of free float) is an excellent barometer to track, which saw the most substantial oil ETF spike from almost 0% early March to ~15% of the free float on April 23.
But, getting back to the point in question, the Short Interest of the largest ETF receiving the most inflows right now has retraced over the last week from its YTD highs, giving more confidence that the buyer of oil ETF is real demand and strong bullish signal for oil markets.
The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.
Soaring US yields trigger the wrecking ball effect as yields become a source of volatility for risk, rather than a source of support