FxWirePro: Heads-up on Crude inventories and WTI hedging perspectives

Crude oil price is surging but we reckon no certain clarity on major trend which has been downtrend but has gone into consolidation phase from February 2016.

U.S. West Texas Intermediate (WTI) futures after briefly topping $50 per barrel, prices are tacked at $49.76 a barrel, up 1 cent as OPEC has sent hints that it could increase compliance with production cuts that began earlier this year.

Especially due to stockdraws, the recent week’s report seems moderately bullish for crude and diesel, bullish for gasoline. The total US commercial crude and product stocks built by 1.1 Mb last week. 

Over the last 4 weeks, combined crude and product stocks drew by 22.4 Mb, or 801 kb/d. US 4w product demand (through 28 July) remained healthy, up 291 kb/d YoY to 20.75 Mb/d (+1.4%). 

This followed very robust June US product demand growth of 794 kb/d YoY (based on the preliminary weekly data and adjusted by SG). The US Petroleum Supply Monthly, released by the EIA very recently, confirmed that May US product demand growth was also very strong; the final monthly figures showed gains of 819 kb/d YoY.

Product demand growth is healthy not just in the US, but globally. Along with unplanned refinery outages in Latin America and Europe, this has been driving strong growth in US product exports, the 404 kb/d Pernis refinery in the Netherlands was completely shut down last weekend due to technical glitches, and won't be back up until the second half of August at the earliest. 

This should further support global margins and product flows from other regions (including the US) into Europe. That said, we remain cautious about the markets in September and October when crude and product seasonality turns bearish.

Option Strategic Perspectives:

Long-dated put skewness translates into higher hedging costs, which is ultimately borne by their all-in cost of production. Currently, a crude oil producer can hedge its 2H18 production against WTI prices falling below $44.70 (90% of current 2H’18 swap price) by selling away potential price gains above $53.70 (call strike which makes the 90% producer collar cost less).

Given that the WTI 2H’18 swap prices currently stand at $49.70, this implies a maximum downside exposure of $5.00 and a maximum upside of $4.00 per barrel for the hedging entity. The upside/downside ratio of the 90% producer zero-cost collar therefore currently stands at 0.80 times.

However, with prices nearing and rising above $50/bbl for 2018, we expect the trend to reverse as producers seek to benefit from the current bearish respite by hedging their future production, which in turn should push risk reversals higher.