Sunday, August 23, 2015

Oil Price Decline May Be Due For a (Brief) Pause

A twofer following Friday's $39.86 WTI print.
First though, some background. Back in January we and FT Alphaville's Izabella Kaminska posted on the opportunities presenting themselves in the cash-and-carry corner of the oil trade:
As We Search For A Bottom In Crude: Floating Oil Storage--Do the Math
That post pointed out that the six month contango was $6.50, more than enough to make the trade work.

We aren't there yet but at $4.00 from the October futures to the April vintage it definitely has some of the bigger houses and maybe even some of the national oil companies firing up their slide rules.

In late May with WTI at $56.74 down 77 cents we posted "The tanker market is sending a big warning to oil bulls". Early but not wrong. Here's how the action turned out:

We expect lower prices this autumn but for now $40.29 seems like a reasonable place to stop falling or maybe even bounce a bit.

From the CME in their Aug. 21 story at the OpenMarkets house organ, a little chart on the steepening term structure of the futures:
Is Oil Volatility Changing Trading?
Oil prices have been on the downswing for more than a year now.  As U.S. crude futures fell to a fresh six-year low last week, rising global supply and subsiding demand from China provide little indication of an end to the trend.  Volatility is still below historic highs, but it remains a significant factor.  On August 12, the Chicago Board Options Exchange Crude Oil Volatility Index closed at the highest level since April.

The story of oil bear markets is one most often told by supply side economics. The U.S. is on pace to produce the most oil since 1972, according to the Energy Information Administration, and drillers have made little indication of curbing production despite price dips and squeezed profit margins.  In fact, U.S. stockpiles remain at the highest levels during the peak driving season in approximately 80 years.  CME Group Senior Economist Erik Norland highlighted this in his recent report.
While Americans are driving about 5% more miles than they did last year, oil inventories have not been declining as much as they usually do at this time of year.  Not only are inventories near record highs, their year-on-year pace of increase is at a record-breaking 25 percent....
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Here's the chart:
http://openmarkets.cmegroup.com/wp-content/uploads/WTI-Contango-Spread-880x440.jpg

Now you don't have to hit me over the head (anymore) to get my attention. I think the CME is trying to tell us something.

And from Mish Shedlock writing at SafeHaven a look back when the same idea can be applied to a look forward:

Oil Crash Continues: West Texas Crude Below $40, Brent Near $45; Floating Oil Carry Trade in Review
The crash in oil prices continues. Here are a couple charts to consider.
West Texas Crude
West Texas Crude Oil (Monthly) Chart
Brent Crude
Brent Crude Oil (Monthly) Chart
West Texas Intermediate broke the $40 barrier to the downside today but is slightly above that level now.

WTI last broke $40 to the downside in 2008 but has not had a monthly close below that level dating back to 2004. Brent is near the $45 mark.

Floating Oil Carry Trade Review In 2008, hedge funds and other big money stockpiled oil in floating ships in the $30s waiting for a rebound. This time they did so at higher prices, and at a cost of $40,000 a day.
Let's investigate how that is working out for anyone still in the trade.
Flashback January 9, 2015: ?Major Oil Traders Book Tankers for Stockpiling Crude at Sea.
A continuous fall in global oil prices has prompted major oil traders to start hiring supertankers as they can benefit from stockpiling crude oil at sea.
The oil giant Shell and energy traders Trafigura and Vitol have booked crude tankers for up to 12 months, said Reuters, referring to the fixture lists provided by tanker brokers and oil traders.
Traders reportedly use the vessels to store excess crude at sea until prices stabilize as in 2009, when more than 100 million barrels were stockpiled this way. Then the news caused outrage over oil "speculators" supposedly waiting to sell oil at higher prices in future.
Shell has reportedly booked two vessels, and Vitol, the world's largest independent oil trader, has booked the TI Oceania Ultra Large Crude Carrier, one of the biggest ocean going vessels with a three million barrel capacity.
The move can be explained by the market phenomenon known as "contango", when spot or current prices fall below the cost of future shipment. It has happened for the first time since 2009 as spot prices fell by more than 50 percent in the last six months. This gives traders more reason to buy oil now, store it in tanks and benefit when demand recovers.
Trading firms have been able to hire the Very Large Crude Carrier (VLCC) vessels for less than $40,000 a day, compared to spot rates of $60,000 to $70,000 a day, according to the lists.
Traders can currently purchase Brent crude for less than $51 per barrel, while barrel for delivery in August costs more than $57, thus, in this case "contango" is more than $6. Analysts say the contango above $6.50 a barrel is needed to cover expenses on hiring a tanker, providing insurance and gaining profit from offshore storage.
West Texas Contango
Crude Oil WTI Futures Prices
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Here's major carrier Frontline's stock price action. Note the move actually began in December 2014 when the Chinese started chartering every tanker they could find.
The stock is not telling us much at the moment but worth keeping an eye on as an indicator:
 
A couple weeks prior (Nov. 13) we posted "Oil Tankers Stream Toward China as Selloff Sparks Boom" (FRO).