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Trader's Corner
This week’s Trader’s Corner looks at the bounce in crude prices.
From June 24 to July 19, West Texas Intermediate (WTI) crude posted a nearly 18 percent gain of $16.65 per barrel. After July 19, when an intraday high of $109.32 and a close of $118.05 had been posted, prices began to fall.
The turn lower occurred after several concerning reports about the Chinese economy. China’s economy was still growing at a breakneck pace of 7.5 percent annually last quarter. However, economic growth has been on a steady downward trend from its once double-digit rate.
Since China is the world’s second-largest crude consumer, the state of its economy and prospects for growth can have a huge impact on how the market perceives potential growth in crude demand. It was not surprising to read numerous analysts talking about crude demand destruction.
WTI crude had fallen to $102.67 by July 30, but then turned sharply higher on Wednesday, the following day. On Wednesday and Thursday, there was almost a perfect storm of events that caused investors to pour money into commodities and equities, pushing crude and U.S. equities indexes sharply higher. Below is the list that influenced the general trade and, more specifically, crude:
• The Energy Information Administration (EIA) reported a nearly 2-million-barrel draw on Cushing, Okla., crude inventory occurred last week. Cushing inventory has dropped 15 percent in four weeks. Cushing is where WTI crude futures settle. Therefore, inventory there has a significant impact on WTI pricing. WTI is now trading just $1.97 below Brent. The spread has been as much as $27.
• The Federal Open Market Committee kept its accommodative monetary policies unchanged at the conclusion of its meeting Wednesday, and it gave no indication it was ready to stop its bond-buying programs. Further, it committed to leaving interest rates low until unemployment falls below 6.5 percent or inflation moves above 2.5 percent. The European Central Bank and Bank of England kept stimulus measures unchanged as well.
• The Commerce Department reported the U.S. economy grew at an annual rate of 1.7 percent during the second quarter. Economists were only expecting 1 percent growth.
• The U.S. House passed a bill to put further sanctions on Iran in hopes of cutting another million barrels per day from its crude exports. That would essentially put it at zero. The sanctions are aimed at getting Iran to stop its nuclear work.
• The Markit Eurozone purchasing managers index (PMI) showed expansion in the European manufacturing sector for the first time in two years.
• European unemployment fell for the first time in two years.
• China’s official PMI report showed a small increase in manufacturing, with a decrease expected. The PMI index for July was 50.3, up from 50.1 in June. Expectations were a drop to 49.9.
• Reports showed U.S. factory activity hit a two-year high in July. The Institute for Supply Management said its index for national factory activity rose to 55.4 in July, up from 50.9 in June. Any reading over 50 means a sector is expanding.
• U.S. first-time unemployment claims fell to a 5½-year low. Claims dropped 19,000, to 326,000, the lowest since January 2008.
Along with all of this positive economic and fundamental news is a plethora of supply disruptions and threats to supply in Africa and the Middle East.
When our clients and subscribers would call and ask why crude was going up so fast, we would go through this list of reasons. Most would have preferred a much shorter answer. The shorter answer would have been something like, “because many investors now believe it is in their financial interest to own crude futures.”
In reality, that would have been the more correct answer. Crude was going up because people wanted it in their investment portfolios. Some people were buying simply because everyone else was buying. Still, there is generally a foundation from where these rallies form.
Even though all of the factors listed were contributing to the crude rally, the draw on Cushing, Okla., inventory had to be the foundation for this particular run higher. The 15 percent drop in Cushing crude inventory over the last four weeks is probably ground zero for this rally.
Cushing crude inventory had been on a slow downward trend through June of this year. The decline was a key reason for the strengthening in price of WTI crude against Brent’s price. At one point in the year, the spread was still $23, but had declined to near even. The spread had started to increase, but has gotten to around $2 again with the draws in Cushing inventory.
We feel WTI crude buyers will remain fairly confident as long as Cushing crude inventory is coming down at this rapid pace. Just like propane producers are trying to bypass Conway, crude producers are trying to bypass Cushing and get crude directly to Gulf Coast and East Coast markets.
Midwest propane inventory is below average right now, but it certainly isn’t for lack of supply. It is simply that local Midwest demand does not warrant carrying high inventory. Barrels are getting pushed south and east to higher-return markets rather than being stored in hopes of a windfall that could come during a tight supply situation – a situation that could have a harder time occurring because of all the production in the Midwest.
One would have to suspect that Cushing crude inventory is likely to move from its historically high levels to below-normal levels as infrastructure capability to bypass Cushing improves. And even though there won’t be the need to carry high crude inventory at Cushing, a below-normal inventory level could make it trade as if we are short crude supply.
We have to remember that crude inventory in Cushing increased because of the inability to get new crude production from the U.S. and Canada out of the Midwest. A fall in Midwest crude inventory would be a concern if there had been a corresponding surge in Midwest refining capacity, but there wasn’t.
In our view, we should probably pay less attention to Midwest propane inventory than we have in the past because the regional markets are becoming better connected. We don’t perceive a lack of propane supply in the Midwest, just lower inventory. Yet the market tends to trade the inventory position.
That is highly likely to occur with WTI crude as well. As we transition to a new normal for Cushing crude inventory, which will be much lower than it is today, there will be a perception of a shortage of supply. However, we all know that U.S. crude production is on a rapid rise.
Keep an eye on Cushing crude inventory for potential changes in crude price trends. If it continues its rapid decent, WTI may trade as if it is in short supply. But if inventory levels out or goes higher, it could prompt a downward turn in WTI crude prices, which could cause a fall in propane prices as well.
Call Cost Management Solutions today at 888-441-3338 for more information about how Client Services can enhance your business, or drop us an email at info@propanecost.com.
WEEK IN REVIEW
Positive news on the global economy and a draw in Cushing, Okla., crude inventory turned WTI crude prices higher.
Propane was strong all week, with gains almost every day but Friday.
Crude has a lot of momentum and support and could certainly go higher. But we remain concerned prices have gone too high too fast and could correct despite all of the good news lately.
LAST WEEK'S DAILY HIGHLIGHTS
Monday: Data showing lower pending home sales in June helped keep crude in its downtrend. Propane separated from crude, with both hubs posting more than 1 percent gains.
Tuesday: Crude continued to fall as traders remained cautious ahead of meetings by central banks and with key economic reports due. Propane resisted the fall in crude, with Conway moving higher and Belvieu unchanged.
Wednesday: A nearly 2-million-barrel draw in Cushing crude inventory anchored a rally in crude. Also the Fed left its accommodative monetary policies in place and the Commerce Department reported the U.S. economy grew more than expected at an annualized growth rate of 1.7 percent in the second quarter. Propane lagged the run in crude with a larger-than-average build in propane inventory for week 30 of the year.
Thursday: Global economic news continued to be better than expected, sending crude up sharply for a second day. Propane outpaced crude to the upside on strong first-of-month buying.
Friday: Crude fell on profit taking after the Labor Department reported fewer jobs were created in July than expected. Propane moved down with crude. |
