Potential double top or anothe leg up? Watch this space

Opportunity to short distillate cracks?

SFOT is a little tied up this am, and thus the post is lat and will be a short one. Gasoline cracks have eased off since DOE came out yesterday confirming the relative increase in inventories. Indeed, days forward cover of Gasoline is now starting to reverse a little. However, what bothers SFOT is that demand is also on the way up, which means prices at current retail level has not hurt US consumers just yet. Perhaps it is substitution of flying holiday with driving holiday in the US at work and we are indeed seeing evidence of this from the airline industry and Jet fuel's relative prices. SFOT's decision to be flat of any Gasoline length proved to be right, but going short is a nono just yet.


However, distillate cracks are high, and with days forward cover on its own reaching another high, SFOT cannot see this strength continue for much longer, and will add a unit of short in this area. This is especially the case when crude stocks are being drawn down and the balance of play is probably now to be long of crude and short of distillates, and long of crude spreads vs short of distillate spreads on weakness.

Bullish on bottom of the barrel?

Option expiry on Nymex WTI today. The open interest numbers reported on Nymex $5 either side of 70 is quite low at this stage, and thus could be a fairly uninspiring expiry, although OTC interests may yet give today a bit of volatility. Weak across the complex is the theme this am, much like yesterday morning in London, only for prices to shoot above $72 once US came in. However, SFOT is aware of some key technical levels being tested in some asset classes. Eg, SPX on its 200day moving average. These are the things that can spark a violent move, infecting the other assets that are in the current reflation play in the process.

The API numbers were a little surprising, in particular Gasoline inventories building by over 2mio bbl. While SFOT touched on this topic yesterday, it is too early to say Gasoline has indeed topped out and is starting to harm its own demand just yet as API did show a strong rebound in demand too. Best to wait for DOE this afternoon for further clues. However, the volatility of these kind of series means some sort of average would be most helpful in finding trends, and SFOT will look at the 4 week average rather than 1 weekly number for further conclusion.

API Gasoline supply

Another topic touched on recently is the strength of sour crude and the weakness of fuel oil cracks. Indeed, the cracks are still under pressure as we speak, while sour crude premium, express in brent-dubai diff, is now trading at its narrowest, almost flat to each other. Causes discussed were OPEC's cut, but also new larger and more sophisticated refineries are able to process sour crude more easily, and then able to feed heavy fuel into the cracker to break it down further. Perhaps this situation will persist for a while, and if so, SFOT is tempted to be long of some fuel oil cracks in the prompter period, and he shall do so.

1% fuel oil crck europe
Brent/Dubai diff



Right, a few more days to go before the start of wimbledon tennis. Being in london, SFOT is naturally surrounded by the enthusiasm of a British winner this year. However, he can see how the pressure and the form of Federer may play a big part in that not happening. Whatever the case, we shall have another 2 weeks of fun next week, more thrilling 5 setters and hopefully good weather!

Is Gasoline getting to strong for its own good?

There is not too much changes in the energy complex today, in particular flat price. With USD getting a bid, and the obvious break in eurusd in a classic head and shoulder development, Crude came under some pressure but holding out this $70 handle is still a sign of strength on it own and the current macro theme remains the same. Although there has been a little correction in the rates world, with 2year rates coming off about 30bps from its high last week, rates have still gone up a long way. With bullish news yesterday that UK CBI has warned BOE may raise rates soon, and the very strong ZEW reading today out of Germany, one may have to admit the greenshoot/reflation play may still have a bit of legs, and speculators in Crude especially have not got any real reason to dump just yet.

Gasoline has made another turn for the highs, and retail gasoline prices are now the highs of the year. Perhaps its speculative strength, perhaps its the fear of hurricanes, perhaps it is fear of further run cuts that will take Days forward cover to another low. Whatever the case, cracks and spreads are definitely bullish but it is at this point SFOT is contemplating taking off length in gasoline. The main reason being he sees no more reason for cracks to head higher, and spreads to be much stronger as the high price may start to eat into demand numbers, although he sees no real evidence as things taking place just yet. Any comments here welcomed...

aug/sep rbob spread
Rbob crck Jul9
US Gasoline days cover

Refining margins are crushed, led by middle distillates and recent Fuel oil weakness.

Market actions suggest we are at a little cross roads this morning. USTs rallied into the close, and continues its rally over night and asian hours. This is keeping a cap on the performance of risk asset including Gold, Oil and giving USD a little boost. Given the HF community's current theme is the reflation trade, there must a quite a few shorts in USTs currently, and perhaps a little squeeze is due in the longer end? In a scenario like this, perhaps it is wise to take off lengths in risk assets for now, and SFOT is happy to return to neutral in his outright exposure at this moment and he shall do just that.

Within the barrel, although SFOT has been pointing out the weakness of the middle of the barrel, one thing that has been consitently weakening is the bottom of the barrel, fuel oil. While this has been the strongest product earlier this year, the recent shine on Gasoline took its outperformance away. Bearing in mind this product is still around some 20% of the barrel, its effect on refining margins is not negligible. The low sulfur fuel oil, which is used for power generation, is a direct competitor to coal and gas. As oil prices keep going higher, fuel oil prices are dragged up, and at some point, coal and gas(which has been underperforming), will be a cheaper alternative. SFOT hears this might be the case now, and end users are switching their input, which is putting a damper on Fuel oil cracks, particularly the low sulfur type. Coupled with good supply coming out of the black sea region, fuel cracks may continue to see a cap. With middle distillate also weak, refining margins are now coming under significant pressure. This is a clear example that the recent rise in price is fairly unwelcomed, and while momentum can overshoot flat price, the faster and higher it goes, the faster and stronger any pullback will be.

Proxy Brent crude refining margin

Low sulfur fuel oil crack at the year's low

China effect and Oil.

SFOT is aware that the release of China's trade numbers overnight has been one of the most highly anticipated number so far this month. Therfore, the less than expected trade balance, topped by much lower exports and imports may be of interest to some macro punters in the commodity space. Exports suggests world trade may not be as rosy as the greenshoot /reflation story suggests, however it is the import story that is more interesting. With a full month of rising prices in May, it is interesting to see this number falling much more than expected. The breakdown for oil related imports is quite clear. Stock piling for crude was very well publicised, but what has not been so well documented is the fall in imports of refined products. Seasoned traders will remember that it was last year in April and May that China imported the highest amount of Diesel, and this sent middle distillates to new highs shortly before the olympics. As previously mentioned, China's import of crude perhaps is a way of diversifying their reserves, but in true demand terms, refined products again shows that depending on China to kick start global recovery is going to take a longer time than what markets are pricing in now.

The DOE data yesterday confirms that of API, crude inventories continues its drawdown in the US, helped by reduced imports and production. This morning also sees a little bullish news from IEA, that demand has been raised by 120kb/d for this year. First evidence of the potential for bottoming of demand is here. This will give the longs of the back end of the crude curve comfort. In fact, SFOT sees that the back end of the curve will reach $100 way before year end if this demand really bottoms and crude stocks keep drawing at a sustainable rate. Apparently a major player loaded up with a bunch of near the money calls 1 year out yesterday, which is a fairly interesting flow in recent times. I shall stress again, while SFOT is long and happy so, he is taking off some outright exposure here and increasing long gamma in the front.

Stay long crude for now, and gamma positive.

A number of factors contribute to the overnight strength in Crude and product prices. 1) The strong API data on crude oil. 2) Weaker USD. As for pt 1), a draw of almost 6mio bbl is likely to put fear in players who are short the front line WTI spreads, in particular weak shorts who are just riding on the index rolls ongoing currently. Indeed, the N9/Q9 spread has already jumped 30c from its weakest on Monday. This number again confirms that crude oil inventories are drawing down, which is consistent with reports of floating storages clearing in the crude oil space, as well as middle eastern crude tightening. Perhaps market commentators and sell side bulls will use this to call for 80, 90, or even $100 crude by year end. However, the truth is that products are still extremely weak, and unless refined products inventories starts to clear in the manner of crude is currently, it is difficult to see a strong recovery in front prices.

Jul9/Aug9 WTI spread

As for pt 2), The theme is now clear that specs are looking at the eur/usd pair to trade WTI and the trend now is on the upside. In particular, with Fed fund pricing in a chance of 50bps rate hike only 2 days ago and reversing a chunk of the move within 48 hours, there is room for USD to weaken and this perhaps is a continuation of the global reflation trade.

Technically, the bull trend begun when the 50d mov average crosses the 100day, however, that was with hindsight of course. The longer end of the curve has been the leader of this latest spike up, and with only pockets of consumers out at the moment, the move up is driven up more by hedgefunds/prop type players rather than real users. If we continue to get see data, both macro wise and oil specific terms of supply/demand balance, in particular from China, SFOT fears consumers might be forced into hedging and push the back end even higher vs the prompt. However, the fear of last year should still be sitting on their minds, especially those who hedged above usd $100. Hence SFOT cannot see this happening soon. Back end still sit stable, while prompt should move about a lot more, especially if we do see a pullback. Gamma in the front end is still recommended here.

Brent z10/z12 spread shows z12 higher than z10 by $1 over past few weeks.