Broken correlations

Published at 11:17 2 Sep 2019 by

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We have rarely had a situation where the physical market has been extremely strong (with some crude differentials even at record highs and term structure consistently backwardated) for almost an entire year and flat price has completely ignored these developments. Even the 100 mb global crude stock draw (OECD: 57 mb and non-OECD: 43 mb) seen since June has been brushed aside. Primary product inventories have only built marginally but stocks of NGLs have surged. Global liquids balances no longer offer an accurate insight into crude or clean products fundamentals.

Moreover, the general aversion towards oil exposure is perhaps at an all-time high. Fears of peak oil demand, unlimited shale growth, a looming global recession and the possible rapid return of OPEC barrels (sanctioned or otherwise), all mean that the market has no faith in the future. So, the back end of the oil curve keeps selling off, capping how much the front can rally.

Two immediate bearish themes dominate sentiment. The first is a fear of a sustained global recession. The second is risk of a deal between the US and Iran that would unleash a wave of Iranian exports. The latter is entirely unjustified as Iran and the US positions remain very far apart.

The former is justified although, after a dismal Q2 19, early indications for July demand growth (+1.6 mb/d y/y) are positive. Preliminary readings across Europe, Korea, Vietnam, India and other Asian economies show a strong rebound while China announced further targeted stimulus measures last week in order to bolster the domestic economy. It is possible that the recovery in July was a one-off driven by restocking after heavy destocking since Q4 18. But if demand manages to stabilise, given the rate of black oil stockdraws, flat price should ultimately rally.

Fig 1:  Global oil demand, y/y change, mb/d Fig 2:  YTD US stocks, indexed to Jan 2019, mb
Source: Energy Aspects Source: EIA, Energy Aspects

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