OPEC Reference Basket
The OPEC Reference Basket extended losses into a second straight month in May, to incur its biggest month-to-month decline since December 2008. It lost a significant 10% of its value during the month, but remained above the key $100/b. A massive speculative sell-off, brief prospects of an easing of geopolitical tensions, record crude stock-builds, weak economic data from the world’s major economies and heightened concern over the stability of the Euro-zone weighed heavily on the global petroleum markets, and this was echoed in the Basket price. Commodity Futures Trading Commission’s (CFTC) reports showed that, during the two weeks to 22 May, speculative traders reduced their net long futures and options and the two main crude oil futures by an all-time record of more than 83,000 positions. Moreover, higher oil supply also played a key role in the easing in crude oil prices during the first half of the year. Slowing demand growth expectations in China and India also reduced a key pricing support. In May, the Basket dropped to an average of $108.07/b, decreasing by a hefty $10.11/b or 9.4%, from April. However, year to date, the Basket averaged $115.69/b, $9.49/b above the same period last year.
Without exception, all Basket component values decreased significantly in May, by twice as much as last month’s losses and registering the biggest deterioration since December 2008; together they lost a sizeable $11.30/b on average. Brent-related crudes — Saharan Blend, Es Sider, Bonny Light and Girassol — fell by $9.90 to an average of $111.40/b, down 8% for the month. Meanwhile, Middle Eastern crudes Murban and Qatar Marine also dropped, by $9.73, or 8%, to $109.19/b. Latin American Basket components — Ecuador’s Oriente and Venezuelan Merey lost even more to average $101.11/b in May, down by $10.13, or 9%. The remaining Basket components, namely Arab Light, Basrah Light, Kuwait Export and Iran Heavy, also lost 9% of their value in May, to end at $107.16/b, which was $10.50 below the previous month.
Besides the direct effect of the drop in the two main futures markets on the overall deterioration in the component values, market sentiment for the regional physical crude oil, that the Basket components are benchmarked against, weakened sharply over the month. In Asia, differentials came under pressure, amid lower official selling price formulae (OSPFs), weaker refinery margins and healthy supply. The poor sentiment weakened the Dubai market structure, with the front month-to-future-month spread narrowing from the previous month’s highs, but remaining in backwardation.
Meanwhile, sweet grades were supported by ongoing Japanese demand for utility crude burning. In Europe, the Urals differentials continued to recover from the record lows seen a month earlier, but lost momentum amid ample alternative supplies, sour and sweet, and despite lower imports from Iran. Some pressure, however, may have resulted from European refinery maintenance marking its second-highest monthly figure this year. Meanwhile, regional light grade differentials slipped, due to the ample availability of cargoes, as well as plummeting values for light distillates. On the US Gulf Coast (USGC), the higher inflows from the Middle East seen in recent months served to undermine differentials for Mars crude, while formula-related regional grades, such as Mexican Maya and Venezuelan Mesa-30, also remained very weak, due to the weakness of West Texas Sour (WTS), a key grade in the formula. Moreover, the strong influx of very light-sweet crude into the Gulf Coast dragged down Light Louisiana Sweet (LLS) differentials considerably to a significant discount to Dated Brent. On 11 June, the OPEC Reference Basket stood at $97.34/b, more than $10 below the May average.
The oil futures market
Global crude oil futures prices took their biggest beating in almost three and a half years. The Nymex WTI (West Texas Intermediate) front-month contract dropped a strong $8.63, or 8.4%, in May, on top of last month’s losses, while the Intercontinental Exchange (ICE) Brent front-month plummeted by over $10.20, or 8.5%, falling for a second month in a row. Numerous reasons were behind the drop, including a massive liquidation of net long managed money positions, heightened concern over the stability of the Euro-zone, a dimming economic outlook, mounting evidence of a steadily increasing global crude stock-build and easing geopolitical tensions. Money managers reduced their net long speculative positions for Nymex oil contracts by a massive 34%, the largest amount on record on an outright basis, over the two weeks in May that prices slid the most, according to the CFTC reports. Data from the ICE also shows that positions on Brent fell by a significant 28%. The collapse happened in line with a near $10/b fall in WTI in the week ending 8 May during a massive sell-off. In addition to this, the announced substantial increase in initial margins for non-hedged futures positions on the Nymex might have forced many market participants to revise down their positions. A weaker global economic outlook and the increasing probability of a new financial crisis in Europe also helped in sending crude prices lower. Fears about European debt resurfaced, with borrowing rates for ten-year bonds in several Mediterranean countries increasing, including heavyweights Spain and Italy. In Asia, Chinese economic data was also well below expectations, as year-on-year (y-o-y) retail sales growth fell to the lowest level for at least five years.
The World Bank also cut its 2012 annual growth forecast for the Chinese economy, which, in turn, slowed emerging Asian growth for this year, weighing down on crude prices. Oil supply fundamentals played a leading role in the price correction too, with higher production for the past six months. Given weak demand, the logical consequence of such high production levels was a massive global implied stock-build. Evidence of growing stocks can be seen in official Chinese data, with an implied stockbuild of 580,000 b/d seen over the first four months of the year. Similarly, US crude stocks have built by 54 mb since the end of last year (equivalent to 353,000 b/d) to reach 385 mb, the highest level since 1990.
Nymex WTI front-month averaged $94.72/b in May, the first time it was below $100/b this year, and this was down 8.4% from the April average. ICE Brent front-month fell by m8.5%, or $10.20, to end the month at an average of $110.29/b. Compared with the previous year, the front-month WTI year-to-date average was up by nearly 3%, at $101.37/b, while ICE Brent was almost 6% higher at $117.17/b. Both contracts were above the key price levels of $100/b and $110/b in May, respectively. The Nymex WTI and ICE Brent stood at $82.70/b and $98.00/b on 11 June 2012, respectively.
Crude oil futures prices fell sharply in the first week of June, when both Nymex WTI and ICE Brent settled below the key $100/b mark, at $83/b and $98/b respectively. This transpired as weak US jobs data, soft Chinese manufacturing and the deepening Euro-zone crisis sparked another broad market sell-off. Crude oil futures sank with Wall Street, which dropped by more than 2%. The Dow Jones industrials average crossed into negative territory for the year.
The futures market structure
The Nymex WTI market structure narrowed its contango by over 30% in May, with the first month-versus-second-month time-spread averaging around 33˘/b, almost 15˘ down from April. This was in line with the start of the crude oil flow from the US mid-continent to the US Gulf Coast, subsequently relieving the logistical constraint at Cushing, Oklahoma. The Seaway pipeline was officially reversed on 19 May and is now transporting crude from Cushing to Houston-area refineries. Initial capacity is capped at 150,000 b/d, but an expansion is set to boost capacity to 400,000 b/d in early 2013. Meanwhile, the ICE Brent market structure steepened its backwardation by almost 20˘ to 55˘, based on the average spread between first- and second month contracts during May. Higher post-seasonal maintenance demand for North Sea crudes, coupled with arbitrage opportunities for Forties crude to South Korea, supported the move. The transatlantic (Brent vs. WTI) spread narrowed by a further $1.60/b in favour of WTI during May, coinciding with the start of the Seaway pipeline-reversal. Although the impact was projected to be higher, the 150,000 b/d did not have a strong impact on the Brent/WTI spread, considering that recent weekly Cushing stock-builds have often been higher than 1 mb, a level roughly equivalent to seven days of outflows at Seaway capacity.
The sweet/sour crude spread
Light-sweet/heavy-sour differentials were mixed again in May. While they widened slightly in Asia, they narrowed significantly in the US and Europe. In Asia, light-sweet/heavy-sour differentials, represented by the Tapis/Dubai spread, widened, despite being a relatively poor month for high value products, with cracks for both gasoline and naphtha falling considerably, even as middle distillates remained stable. On the other hand, fuel oil managed to gain slightly, but this supported Dubai more than Tapis and so should have resulted in a narrower spread. Instead, the widening spread can most likely be attributed to a slightly wider Brent/Dubai spread, which will temper arbitrage inflows of West African grades at a time when more and more Asian refiners come out of maintenance. As a result, the Tapis/Dubai spread during May widened to an average $9.90/b in favour of Tapis, from the $9.50/b in April.
In Europe, the Brent/Urals spread narrowed further by a significant amount from multimonth lows, supported by the end of maintenance and tighter availability. Urals also benefited from the \ anticipated lower imports from Iran as of 1 July, while the number of available Iraqi barrels also remained limited. The Brent/Urals spread stood at $1.05/b, almost halving the previous month’s spread. The US Gulf Coast (USGC) sweet and sour grade-spread, represented by the Light Louisiana Sweet (LLS)/Mars spread, narrowed by over $3.50/b, as a result of the higher availability of light-sweet crude both from West Africa and from domestic shale crude. On average, the spread in May stood at $3.11/b, compared with $6.66/b in April, in favour of LLS. Again, the product market had little to do with this, as LLS cracks were very strong, while Mars was quite weak, compared with other non-US grades. More and more domestic light crude is ending up in the USGC, even though refiners do not need it, as they prefer a much heavier crude slate in line with their greater complexity. Since US law forbids export of domestic crudes, a glut of lightsweet grades is growing in the US Gulf that will only increase with the recent reversal of the Seaway pipeline. Moreover, the strong influx of very light-sweet crude into the Gulf Coast has dragged down LLS differentials considerably, relative to international crudes, with LLS averaging a discount of $1.50/b to Dated Brent in May.