Oil Market Special: Has oil bottomed out?

Market Analysis / 3 Min Read
Stephen Innes / 04 May 2020

June Brent traded up with nary a settlement risk to be seen as the contract was taken off the board overnight. For July Brent, the new front month is trading up towards $27 and its discounted cousin, July WTI, moving in on $22.

Lovely bounce off the lows for June WTI this week as the change in the direction of travel reflects traders refocusing on the inflection point in demand; the gradual lifting of mobility restrictions in large economies is helping.

Upbeat remarks from Dr. Fauci regarding testing of Gilead's Remdesivir virus treatment added to the bullish day as anything that helps with returning economies’ 'new normal' to something that resembles old normal is exceptionally bullish for oil markets.

And the EIA inventory data offered up some small hints of encouragement; the crude build, while significant, was a little less than expected and the gasoline draw was interpreted as a sign of some improvement in demand.

Last week was the second straight week of inventory and product demand figures suggesting a bottoming of the US market. The crude inventory build of 9.0Mb (plus SPR +1.2Mb) was bullish vs. consensus +10.6Mb and API +10Mb and smaller than the previous week’s.

Technical selling pressures are usually relatively short-lived. And on the first signs that market shorts were losing the upper hand after the colossal oil funds rolled forward, it probably signaled speculative money to move in on front end weakness.

Both WTI and Brent oil front contracts are up, but it’s the fall in the contango that is far more interesting. The fact oil prices along the curve are providing much better price discovery should bring investors back, fingers crossed.

But as June long positions reduce, so does June delivery risk and this allows June WTI to trade on a more fundamental scrim. The latter is extremely important; it will probably lead more brokers around the world to lift the DNT (do not trade) enforced restriction and bring back more investor interest in spot markets.

Demand has most likely troughed with several large economies now considering 'exit strategies' or a 'new normal' and lifting draconian lockdown restrictions. All the while, OPEC+ quotas are due to kick in on Friday, suggesting short term supply conditions have likely peaked. There’s probably another 3-5 dollars left in the June tank, which should take us to or through the 20-dollar inflection point.

With some technical overhang left in WTI, the front-month remains prone to roll on en masse. Position traders will likely take advantage of narrowing front-month contangos to execute roll strategies at opportunistic times, especially on the move under $2 forward. This could weigh until long positioned June WTI open interest is low.

However, this is a battle of the execution algorithms that provide extremely poor price discovery when the sell-buy risk management protocols are executed. The market makers' execution engines see these trade coming a mile away and the program immediately pulls down their pricing ladders on the first sign of selling momentum, as the machine assumes a June-July swap is coming as, given the liquidity conditions, no one is going to trade June WTI in large size unless they need to.

That could be why we saw a whippy move during the 4 PM London Fix yesterday. Although that time is primarily a currency hedging channel, the London close is also a time for colossal settlement risk across a broad spectrum of assets.

But, over the short term, if WTI prices can close above $20.27 – a critical inflection point for oil prices, which is the day before the steep drop that saw nearby May futures plunging into negative territory for the first time in history – the impact of last week's historical splat in crude oil prices would be lessened while also boosting sentiment.

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.

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