Russian Crude On Cusp of Embargo, and Yet Benchmark Prompt Spreads Are Weak

By: Harry Altham, Energy Analyst, Market Analysis EMEA & Asia

Tue, 29 Nov 2022, 12:48

Russian Crude on Cusp of Embargo, and Yet Benchmark Prompt Spreads Are Weak

Harry Altham

Energy Analyst, EMEA & Asia

Brent has pushed $5 higher since 2pm GMT yesterday, largely due to the increasing pace of rumours suggesting that OPEC+ will pursue another production cut to counter market weakness (the meeting is planned for next week). Meanwhile, U.S. retail gasoline prices have fallen to their lowest level since Russia invaded Ukraine on 24th February (at $3.52/gallon); weakness in RBOB futures indicates that prices are likely to fall beneath $3.00/gallon over the Christmas period. Continued strength in diesel markets means the WTI 321 crack remains above $30 (having gone beneath that level yesterday for the first time since September).

Source: CME, AAA, StoneX

technicals aligning with fundamentals

WTI’s November looks set to be highly volatile right to the last. Amid low volume, the U.S. benchmark has made $2+ down-moves on eight of the last twelve days, losing $16 in that time before bouncing off the YTD low of $74/bbl yesterday. The mini-recovery has seen WTI breach the five day moving average to the upside this morning, and we are seeing an apparent formation of an inverse head and shoulders pattern which could indicate that the last two weeks’ downtrend is approaching an end. We believe the technical argument for a period of price support is supported by our fundamental view on the prompt spread, where we have observed an increasingly positive 90 day correlation with the WTI spot contract. The level we see as being critical is $80 in WTI January 2023, which is also acting as a psychological marker in the market.

Source: Bloomberg, StoneX

Source: Bloomberg, Calculations by StoneX

To be clear from the start, our view is that the WTI prompt spread is undervalued (it is currently in a contango of $0.04). Europe is two days away from losing over 1M bbd of its total crude supply from Russia; the threat of such an eventuality was precisely what saw the spread touch $4.00 in March. Though Europe will be more reliant on barrels from East of Suez than the United States, the 3M+ bbd of U.S. crude exports (currently flowing to Latin America) will be more valuable on the spot market as Europe faces significant constraints in its energy security. Of course, major macroeconomic headwinds, sustained zero-COVID in China and the likely continuation of 1M bbd of pipeline imports from Russia act as mitigators, but the physical market is experiencing pronounced pressure and we believe this is under-reflected in the WTI spread. Though the Brent second spread is in backwardation (the prompt spread is in contango as it approaches expiry), we believe that the Brent / WTI prompt spread differential could strengthen for Brent as buy-side pressures squeeze the European physical system over the winter months.

Source: CME, StoneX

CHINA RESPONDS TO RARE PROTESTS BY EARLY STAGE PREPARATION FOR ECONOMIC REOPENING

China has responded to the weekend’s protests by announcing a policy to boost vaccinations among older citizens, which aims to improve immunity within the population. China has faced a combination of issues with its inoculation programme, including a meagre 70% uptake among over 60s, and a roughly 40% efficacy of the Sinovac vaccine against Omicron. Though Sinopharm shares rose by 2.9% today in Hong Kong, we believe much uncertainty remains as to whether China will be successful in its initiative. The new legislation does not mandate Chinese citizens to get a booster, so vaccine hesitancy is likely to remain an issue. Furthermore, will the booster be done with German-made vaccines (a deal was signed between Chancellor Scholz and President Xi earlier this month) or will the weaker Chinese-made vaccines still take the lead? However, we would argue: does efficacy even matter here? The signal by the Government is clear; immunity is the path to economic reopening – pent-up oil demand could be on the horizon in the world’s largest importer.

Energy

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WTI and Brent crude are moving to different beats as a possible U.S. Iran deal reshapes the oil market. The two benchmarks are pricing Strait of Hormuz risk in their own ways, and the gap between them says a lot about where crude goes next.

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