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Analysis: Crude futures rally on smaller-than-expected stock build, Middle East conflict

Contango casts bearish shadow across oil complex

Highlights

NYMEX crude's term structure will be closely scrutinized this spring as an indicator of market fundamentals after the April/May spread flipped last week from backwardation to contango.

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* Smaller crude builds nearly erase surplus

* Gasoline, distillate draws likely

* Refinery utilization expected to rise

The main question will be whether the shift in term structure reflects seasonality and could therefore strengthen once winter maintenance ends and refinery activity picks up.

Alternatively, the shift to contango could signal structural weakness driven by the inability of demand to keep pace with soaring US production.

A persistent contango could chase speculative length from the market, a bearish catalyst in its own right, which could then pull NYMEX crude futures below the low-$60s, where prices have been of late.



Crude stocks have increased six of the last seven weeks, in line with seasonal trends, though the size of these builds has been smaller than usual.

Analysts surveyed Monday by S&P Global Platts expect inventories built a further 2.6 million barrels last week. For the same period, stocks rose by 5.4 million barrels on average from 2013-17.

The builds have been smaller than in years past, allowing for the surplus to the five-year avreage to decline. Inventories were 0.72% above the five-year average the week ending March 9, down from 25% in mid-September and 36% a year ago.

This tightening sparked a rally in oil futures that began in September when NYMEX crude was under $50/b and its term structure was in contango.

By late January, NYMEX crude topped $66/b -- a three-year high -- and the nearby spread was backwardated for the first time since November 2014.

But the tide began to shift in February amid turbulence in global financial markets that pulled oil lower as part of a broad rotation away from risky assets and toward so-called safe havens.

There was also concern that the rosy assumptions regarding global economic growth could be derailed, hurting oil demand by extension.

That was significant because any downward revision to global demand could tilt the net balance in favor of oversupply for 2018.

In its latest monthly oil report, OPEC said last week that output from producers outside OPEC will likely increase by 1.66 million b/d in 2018, outpacing expected demand growth of 1.6 million b/d.

That marked the first time since OPEC's analysis arm began forecasting 2018 figures in July 2017 that the estimate of non-OPEC supply growth has exceeded its prediction for global demand.

The International Energy Agency said last week that global supply will likely increase this year by 1.8 million b/d, led by US shale, while global demand is likely to rise by 1.5. million b/d.

MONEY MANAGER POSITIONING

Such a narrow margin between oversupply and undersupply raises the stakes for OPEC producers to maintain strict discipline with agreed cuts that went into effect January 2017 and expire at the end of 2018.

It also raises the potential for political headlines to morph into market-moving events, like last week's firing of US Secretary of State Rex Tillerson by President Donald Trump.

Likely incoming Secretary of State Mike Pompeo could auger a more hawkish US foreign policy that results in 1.4 million b/d taken off the market if the White House ramps up sanctions on Venezuela and Iran, analysts said.

If even only part of those disruptions materialize, that would help tighten the global supply-demand balance, though downside price risks still loom.

For one, money managers could rush to liquidate length. That would likely exacerbate price declines because the group's short position is too small to provide much of a counterweight.

The latest data from the US Commodity Futures Trading Commission shows money manager length in NYMEX crude futures at 455,113 contracts, while the short position stood at only 30,106 contracts the week ending March 13.

PRODUCT DRAWS LIKELY

Another key variable to watch will be US refinery utilization, as brisk activity this spring and summer would help absorb supply.

Refinery demand typically picks around this time of year as planned repairs are finished and keep rising through mid-summer.

Utilization dipped to 87.8% of capacity the week ending February 23, but then increased each of the next two weeks.

Analysts expect the utilization rate rose 0.2 percentage point last week to 90.2% of capacity, versus 85.1% a year ago.

However, the pitfall of steep refinery activity is gasoline supply possibly exceeding demand, a scenario made more likely given the cushion provided by current inventory levels.

Gasoline stocks were 3.7% above the five-year average the week ending March 9 at 244.7 million barrels. Analysts are looking for a decline last week of 1.8 million barrels.

Nor has the NYMEX RBOB crack spread been particularly strong. The crack against WTI has averaged $18.80/b this month, versus an average of $26.20/b for the same period from 2013-17.

Distillate stocks were 2% below the five-year average at 133 million barrels the week ending March 9. Analysts expect distillate stocks declined last week by 1.8 million barrels. --Geoffrey Craig, geoffrey.craig@spglobal.com

--Edited by Derek Sands, newsdesk@spglobal.com