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US oil import binge: distorted derivatives or shale bust?
[NEW YORK] New York and London oil futures markets are sending a dangerously misleading signal to the real world, according to a growing number of analysts and physical traders. The message: the United States wants more oil.
Oil derivatives traders have bid US benchmark West Texas Intermediate crude to a premium versus global market Brent for the first time since the shale boom began in 2010, a rally that emerged after the abrupt end of an export ban that producers said had forced them to sell domestic oil at below-market rates.
As a result of the inversion, which is now evident in every contract out to August 2017, importing light, sweet crude to the United States has become economical for the first time in years. Vessels carrying up to 500,000 barrels of day of Norwegian and Nigerian crude are expected to arrive at US ports in the coming weeks.
While the economics may work today, some traders in the cash market for domestic US crude worry that it is sowing the seeds of a further slump in prices that could emerge this spring.
The hedge funds and speculators who dominate global futures markets are overestimating the impact of ending the export ban and the eventual decline in domestic shale production, they say, ignoring the fact that the gaping spread has spurred an armada of import cargoes that could deluge the US market.
The second quarter could be a moment of reckoning, they warn, with the extra imported crude arriving just as many US refiners shut down for work. The spring maintenance is expected to be particularly extensive in the Midwest region where excess crude tends to accumulate. "The spread is showing that we 'need' crude, but how much crude does the US really need?" said one US physical crude trader. "With all these imports and turnarounds, there's going to be just too much oil around." The unwind has begun to emerge this week. On Wednesday, the March spread between Brent and WTI crude WTCLc1-LCOc1 ended at 47 cents, down from a five and a half year high of US$1.45 a barrel on Friday. The front spread had traded at around minus US$3 in early December, before the ban was eliminated.
WTI could fall to as much as a US$2 a barrel discount to Brent in the second quarter on growing nationwide stocks, analysts at UK bank Barclays warned last week.
To be sure, most dealers say the issue is about a short-term dislocation, not the longer-term outlook.
Most expect US crude to trade at parity or a premium for much of the next several years as domestic output declines further and demand remains strong, while global output is rising amid wobbles in economic powerhouse China.
There are several alternate explanations for the inversion.
For instance, US crude oil production could be falling far more swiftly than current estimates reflect, tightening the market. Most reliable output data is months in arrears. November production from North Dakota emerged only last week - and showed output rising for a second month, despite repeated forecasts for a decline from the US government itself.
But such an explanation would seem at odds with outright prices, which have crashed more than 25 per cent so far this year on worries that the glut is worsening rather than improving.
The positive WTI/Brent spread is "completely out of sync"and will need to flip if US output doesn't fall, says Clayton Vernon, a trader and economist with proprietary trader Aquivia LLC in New Jersey.
Another option is that exports are already flowing so quickly that they have buoyed domestic prices at the cost of Brent, adding to a global market share battle.
This too seems dubious. Only two small cargoes of US crude have been exported since Congress moved surprisingly quickly to end the decades-old ban in mid-December.
Those cargoes may be part of the disconnect in the market. Most dealers said that at current prices, it makes little sense to ship the crude to Europe rather than sell it domestically. But some companies may be eager to show they are taking advantage of the open window, skewing markets.
The chief concern of physical traders is Cushing, Oklahoma, the biggest US storage hub. Inventories here have risen to record highs at just 9 million barrels shy of their theoretical limit, US Energy Information Administration data show, and filling to the brim could trigger another leg down in the 18-month price rout. "After you build stocks for 10 weeks in a row, we all know what path we're on. March looks to be a good litmus test," said John Saucer, vice president of research and analysis at Mobius Risk Group in Houston.
The builds in Cushing will likely be exacerbated by BP Plc conducting two weeks of planned work on its 250,000 barrel-per-day crude unit in Whiting, Indiana, starting in early March.