FxWirePro: Brent futures soar to resume bullish streaks, what causes flip in crude forecasts – Open Arbitrage via box spreads

We raise 4Q’17 oil price forecasts by 4.50/bbl on Brent and $1/bbl on WTI to reflect the tighter balances now forecast, to $54.50 and $50.00/bbl, respectively.

Similarly, for 2018 we raise Brent to $47/bbl, and WTI to $43.25/bbl as we shift the assumption about how long OPEC-NOPEC will sustain production through to the end of 1Q'18. This keeps us bearish outright pricing, versus current spot and futures values, implying the better value for producers to hedge output than for consumers to hedge fuel costs.

Crude oil prices softened in the early part of the week, following the strong expiry of November Brent futures last week. However, last Wednesday’s EIA data, positive comments from Saudi Arabian and Russian government officials during King Salman’s visit to Moscow, and a renewed focus on possible interruption of Kurdish exports were all supportive of prices. Friday’s product-led price weakness validated our view that in the very short term a further unwind of hurricane-related product market tightness is likely, even as Tropical Storm Nate approaches the US Gulf Coast.

Following last week’s $2/bbl increase in 2018 Brent forecasts to $47/bbl, this week we identify what catalysts would flip the view on prices positive and highlight some of the key risks to our price forecasts, which predominantly are on the upside.

Short-term price support from OPEC’s deal is not the issue that concerns us for 2018. Rather, it is the risk that higher prices would incentivize increased supply (via higher capex) from US shale which could coincide with the last supply contributions from the 2013-2014 investment cycle and in conjunction with returning OPEC output swamp market balances.

Concerns that OPEC compliance would fade into 4Q’17 now appear unfounded. Furthermore, stronger than assumed economic growth offers the potential for tight market conditions to continue if OPEC extends the current deal for another nine months.

Box spread construction: Buying 1m ITM striking call ($52) and writing OTM striking call ($60) of the same expiry, simultaneously, buying 2m ITM striking put ($61) and writing OTM striking put ($51) of the same expiry are advocated to execute this position.

The long box is used when the spreads are underpriced in relation to their expiration values. One can achieve limited risk-free yields, in effect, the arbitrager is merely buying and selling equivalent spreads and as long as the price paid for the box is significantly below the combined expiration value of the spreads, a riskless profit can be locked in immediately. Courtesy: JPM