So Long

The crude and products markets are selling off hard and prices are hitting three-month lows -- an opportunistic reshuffling in the paper market is pulling prices down. Gasoline, diesel and crude prices in the US and Europe have just hit multiyear highs and traders are booking profits with their sales, bidding farewell to a summer that delivered on its promise of higher demand. Exchange prices had gone up because the physical market on which these trades are based is stronger than before the summer. The expected upswing in oil demand came through as promised and tightened crude and product inventories (related). But the prospect that this upswing would continue at a relentless pace has dimmed. The spread of the Delta variant is causing lower demand for transportation fuels like jet fuel and gasoline, mostly in Asia. Risk capital decided it’s a good time to take money off the table and sell their long positions that were based on the potential for even higher prices. It has also become apparent that China takes action when crude prices rally. China has successfully helped to take the heat out of the crude price rally by first drawing down commercial stocks and then tapping strategic reserves (related). Lower crude imports in China have helped prevent Brent running to $80 per barrel. From the start of June, Brent has averaged $73. Yet, the crude market remains pretty tight -- simply less tight than before. Brent dropped this week below $66, but the physical market shows that supply remains below demand in the second half of 2021. A key barometer for this undersupplied market is the one- to six-month price spread for Brent futures contracts, which shows a backwardated premium of $2.30 for front-month contracts over loadings six months out. That is less than the $4 from a month ago, but traders are still willing to pay a premium of some 40¢/bbl per month to buy this crude earlier rather than later. Further, refiners are willing to pay a premium of some 40¢/bbl over the front-month Brent contract, for October shipping, to get a spot cargo priced off dated Brent, loading in September. The same is true for US benchmark West Texas Intermediate (WTI). The one- to six-month spread has narrowed its premium a little more than Brent -- from $4 to $1.65. Strong domestic demand is waning now and shale output is rising. These prompt premiums offer no financial incentive to store oil to use at a later date, since it loses value. Instead, it will continue to tease inventories out of tanks, which is the goal of Opec-plus, as their output policies have more impact in a tight market. Underappreciated is the ongoing recovery of the products market. Global product inventories are hard to measure but forward curves for products around the globe show that gasoline, naphtha and low-sulfur fuel oil are tight, and all trade in backwardation. Liquefied petroleum gasses have also moved into shallow backwardation. The laggards remain jet fuel and diesel, especially in Asia. They are in contango, but the diesel contango is so shallow that inventories are draining. It is a matter of time for these stocks to become tight, providing another fundamental support under crude prices.