The Physical Oil Market Is Screaming Undersupply

|
Includes: BNO, DBO, DTO, DWT, NRGD, NRGO, NRGU, NRGZ, OIL, OILD, OILK, OILU, OILX, OLEM, OLO, SCO, SZO, UCO, USAI, USL, USO, USOD, USOI, USOU, UWT, WTID, WTIU, YGRN
by: HFIR
Summary

Brent timespreads are screaming higher indicating the market is in a major supply shortage.

The Brent 1-2, 2-3, and 1-6 timespreads are saying the physical oil market is very short barrels. In fact, the 1-6 timespread is saying the market is in the biggest-shortage-this-cycle.

WTI 1-2 month remains weak while 2-3 month is nearly in backwardation. The US market tightness is literally right around the corner.

But this doesn't mean we are going long UWT yet as we are still waiting for technicals to bottom out.

Note: This article was published as Oil Market Fundamentals 5/3, which is a new daily oil market report we publish to HFI Research subscribers.

-----

We are seeing quite the radical divergence between flat prices and physical timespreads again. This isn't the first time this has happened, but if the past is any guide, then it's only a matter of time before flat prices move up alongside physical timespreads.

The Brent 1-2 is roofing today to 83 cents and the 2-3 is following closely behind at 66 cents. More telling of the future oil market outlook is the 1-6 month Brent timespread which reached a new cycle high today of $2.90/bbl.

1-6

1-2

2-3

We have studied the oil market extensively over the last 4 years and if there's one thing we know with a decent amount of confidence, it's that physical timespreads have always been a leading indicator of whether the oil market is undersupplied or oversupplied. Clearly, energy investors are not even looking at these because the timespreads are screaming undersupply, undersupply. While energy equities continue to languish.

In fact, not only are energy equities not paying attention to this, it appears the quant funds that actually trade oil are also not paying attention to this. Whatever that's causing their focus to shift away from the increasingly higher backwardation in Brent timespreads will come home to roost.

Our view is that if the Saudis are focusing their attention on flat prices while physical timespreads are saying Brent should be $80/bbl, then Saudis' actions will only further enhance the tightness in the physical market which will then inevitably translate to higher oil prices down the road.

In addition, everyone's focus appears overly fixated on US crude storage which has been bogged down by disappointing refinery throughput figures and unexplainable adjustments. Next week's early estimate shows a draw developing and depending on the throughput, the size of the draw varies.

With that being said, there's also something else strange happening on the WTI timespread front as well. While the 1-2 remains weak potentially highlighting that refinery outages will persist a while longer, the 2-3 is almost into backwardation.

WTI 1-2

WTI 2-3

To us, this may be a great indicator to determine the speed and pace of the draws we see in the US, and it's something we will be incorporating into our OMFs going forward.

If this is correct and the 2-3 month timespread is saying the US oil market balance tightens substantially in the coming month, then we know with a decent amount of confidence that the storage draws in the US is literally right around the corner. Patience is needed, but the market is saying we are on the right track.

As for going long UWT or not, we are still waiting for technicals to bottom out. The TSI continues to trend lower so we don't know when it will bottom technically and while Brent timespreads are screaming an undersupplied market, flat prices could dwindle as CTAs refuse to go long.

Nonetheless, the physical market is a great leading indicator and we are seeing very encouraging signs.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.