Oil defies gravity for now on stimulus hopes, geopolitics

NEW YORK: After an almost unambiguously bad US weekly inventory report, it is clear that the bulk of support for oil prices is not coming from any global physical market fundamentals.
Very short term logistical disruptions in the North Sea and the Baltic have helped skew Brent futures higher, but the overall news flow on global oil supplies has been neutral to bearish.
Likewise, a steady drum beat of soft or downright bad economic data calls into question any hope that oil demand might surprise to the upside.
Rather, a wall of worry over the political situation in the Middle East and a wave of bets on radical new action by the world’s central banks to reflate the economy are keeping bears in check.
Consider the evidence from the US. Refineries there have ramped up operations to very high levels yet crude oil stocks rose everywhere but the Midwest.
The surge in refinery activity is also finally filtering through to stocks of refined products.
Gasoline inventories jumped a staggering 4.1 million barrels, a mammoth increase considering it comes when driving activity is supposed to be highest.
The gains in gasoline cut the year-on-year stocks deficit to 3.5 million barrels. On the East Coast the stockpile shortfall has shrunk to only 1.8 million barrels.
Little wonder gasoline futures have been the hardest hit in recent weeks.
The only pocket of fundamental strength lies in distillates, where despite a weekly gain in stocks, the year-on-year deficit in US inventories rose to 26.6 million barrels, the biggest gap yet between 2012 and 2011 weekly stocks.
But let’s face it, traders are not buying crude oil because of fears of a distillate crunch this winter. And certainly oil refineries are not buying crude for this reason either.
Analysts at Bank of America Merrill Lynch argued recently that the oil market faces a volatile winter for heating oil and diesel prices if distillate stocks do not start to build much more rapidly in the coming weeks.
That view is surely correct but the main impediment to building stocks is the structure of the forward price curve.
Refiners are not going to make the fuel if the forward curve will not allow them to, at the very least, offset the cost of storage.
At this time last year, ICE gas oil futures were in contango, encouraging surplus production and the building of inventories. This time around they are backwardated, which imposes losses on anyone holding product for delivery later.
The present market structure encourages oil refiners to produce as little as is needed to meet anticipated demand and to rely on imports or stocks to over any shortfalls.
Nor can other market participants be expected to willingly take a loss buying up prompt supplies to store for anticipated winter demand.
If anything, the forward curve suggests consumers are reluctant to buy due to the state of the economy. No one wants to still be dancing if the music should come to a halt and oil prices plunge.
At some point this behavior has to end. Stocks cannot decline forever. But here is the problem for the bulls. Stocks of distillate in the US are on the rise.
The US matters as it is a huge exporter of distillate fuel.
Growing inventories in the US mean the day of reckoning when the tanks run dry and force a scramble for spot barrels is being put off for a bit.
Whether this comfortable situation continues will depend on the state of the market in the fall when autumn maintenance will slow refinery output.
But the above analysis means the relative value in the oil complex lies in distillates at the expense of both crude and gasoline.
Either distillate prices will have to rise and shift into contango to encourage more production or margins will have to expand to achieve the same result.
That leaves traders buying oil as a hedge against geopolitical risk and as a bet on more central bank money printing , otherwise known as “quantitative easing” (QE) as the last line of defense for crude.
It’s a formidable force, as this week’s price action would suggest, with bad fundamental news struggling to get traction in the market.
Yet consider the impact of past rounds of quantitative easing in the United States.
Clearly the impact on the economy from past QE efforts has been insufficient to boost output growth to “takeoff speed” or additional rounds of money printing would not be needed.
So that makes more QE, on its own, an unlikely source of long-term support for crude, barring outright purchases of oil by the Federal Reserve.
That leaves geopolitics. But “geopolitical worries” are rarely a solid basis of support for oil prices. Crude slumped in June just as the full implementation of the latest round of Western sanctions against Iran approached.
The risk for those betting on impending “macro” supports for the oil price is that these supports fail to materialize or the market shifts focus to other factors.
If it shifts back to the fundamental state of oil supply and demand, the oil price is unlikely to be so well supported.
— Robert Campbell is a Reuters market analyst. The views expressed are his own.