Crude oil markets have shrugged off increased political tension in Venezuela, a potential shift in US policy with regards to Iran and increased geopolitical risk on the Korean Peninsula to close roughly 7% lower on the week, at the time of writing.

A renewal of Iranian sanctions could result in the removal of 1.0 mbd of crude supply from the market. Similarly, the deteriorating economic conditions in Venezuela could destabilize crude exports which are running at approximately 1.5 mbd.

Much of the apparent cause for the retracement in prices has been attributed to a wash-out of speculative length triggered by another small draw in US crude stocks. However, it would be wrong to blame the drop in price on just this. Beyond the weekly EIA data, it is evident that Atlantic Basin crude markets are still struggling to clear.

The North Sea crude market differentials have slumped in recent weeks, highlighting the tepid pace of market tightening thus far. Consequently, prompt barrels need to discount to clear to Asia. If cash markets are struggling to clear, it calls into question the bullish view that we hold for price developments. Furthermore, we note that JP Morgan technical analysts took profits on their long Brent position on Wednesday.

Three differentials illustrate the pressure crude markets are under.

First, Brent futures market structure has widened over the past month to -$0.50/bbl. This is close to supporting floating storage economics and we note is a bearish sign for output price developments.

Second, the North Sea crude differential to the futures market has tumbled to four-month lows and within the physical crude market, the discount on prompt crudes versus deferred cargoes has slipped to its lowest level since before the OPEC meeting.

Ahead of next month's OPEC meeting on 25 May, we consider what benefit OPEC members have gained from their decision to cut production and at what cost? We remain of the view that OPEC will need to extend the current agreement to reduce supply and given the rapid bounce in US shale drilling activity in the past 6 months.

Hedging strategies to arrest bullish risks:

We’ve already advocated below option strategy to keep above forecasted bullish price risk on the check.

Keeping the both fundamental and technical factors in mind, it is advisable to go long in 1M (1%) OTM 0.36 delta call while writing 1W (1%) ITM call with positive theta and delta closer to zero (both sides use European style options), this credit call spread option trading strategy is recommended when the underlying spot FX price is anticipated to drop moderately in the near term and spikes up in long term.

The return is limited by ITM shorts. No matter how far the market moves below that point, the profit would be the maximum to the extent of initial premiums received.