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Schork Oil Outlook: Can You Really Trust History?

Stephen Schork, Editor, The Schork Report
Thursday, 22 Apr 2010 | 11:02 AM ET

Yesterday (Wednesday), the DOE reported a 1.89 MMbbl build in crude oil stocks, blowing away analyst expectations of a 0.75 MMbbl draw. Nymex crude prices dipped after the release but, surprisingly, recovered in the afternoon to end the day close to the open.

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In fairness, the build may be a true up to the previous week’s unexpectedly large 2.22 MMbbl draw. The cumulative change for the first three weeks of April stands at +1.67 MMbbls, only slightly higher than the +1.28 MMbbls seen by the 2004-08 timestep.

But the bulls should not get carried away.

As analyzed in today’s issue of The Schork Report, producers and traders are responding to the contango and the incentive to build supplies. Stocks rose by 1.85 MMbbls in the Cushing, Okla. hub, the largest build ever seen by Cushing in April, bringing stocks there 15.5% above last year and 60.6% above the 2004-08 timestep.

The East Coast (PADD 1) also saw a 1.28 MMbbl build, while the Gulf Coast (PADD 3) saw a 2.63 MMbbl draw. The Gulf Coast’s drop can likely be explained on imports to the region being 3.5% below last year and inputs in to refineries being 4.6% higher. This was the opposite movement of imports and inputs on a national scale.

Total imports rose by a large 0.73 MMbbls/d (or 8.3%, narrowing the year-on-year deficit from -5.4% to -2.5%) and crude oil runs fell by 0.14 MMbbl/d, but remain 1.1% above last year. Given this increase in imports and drop in runs, it is little surprise that total crude oil stocks are 10.5% above the 2004-08 timestep and 4.0% below last year.

On the major products side, mogas stocks blew away analyst expectations of a 0.50 MMbbl build by increasing 3.59 MMbbls, the largest week-on-week increase for April since 2004. However, traders were not and likely should not be too concerned. A full 42% or 1.51 MMbbls of the build occurred on the West Coast (PADD 5), a market traditionally disconnected from Nymex pricing.

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Unless we continue to see exceptionally large builds, it is unlikely that the spike will have serious implications on the futures contract.

On the breakdown, we are ramping up for heavy summer demand — gasoline production was up 1.5 MMbbls/d and remains 3.4% above last year, and total imports mirrored the previous week’s 0.185 MMbbls/d decline to rise 0.185 MMbbl/d, although they remain 32.3% below last year. Meanwhile gasoline demand fell 0.12 MMbbls/d and is only 0.4% above last year.

Interestingly, gasoline blending component inputs dropped by a large 0.12 MMbbls/d and are 34.2% below last year, implying potentially reduced production in the coming weeks. The middle of the barrel saw a bearish report yesterday. Total stocks rose by 2.10 MMbbls, continuing to hit a record high for April at 148.88 MMbbls, 4.6% above last year and 36.3% above the preceding five year timestep. Total distillate demand dropped by 3.3% while ultra-low sulfur diesel stocks rose by 0.74 MMbbls and now stand 6.1% above last year.

Despite all these bearish indicators, the Nymex heating oil contract showed exceptional strength, gaining >1%. Traders may have been looking at imports, which were 14.7% lower for ULSD and 42.4% lower for total distillates. As such, the market is paying an ever widening discount to take barrels off of the spot market and place them into storage.

To wit, we have seen a virtual wave of crude oil flood into the Nymex hub in Cushing, Okla. (PADD II). Supplies here have surged by 4.2 MMbbls or 14% since February. In the process a 4.6 MMbbl (-13.3%) year-on-year deficit has since morphed into a 4.6 MMbbl (+15½%) surplus. Current supplies, 34.1 MMbbls, are now within 5% of the record we saw at the start of the year.

In this vein, capacity at the Nymex Hub is a hotly contested debate. Responding last year to criticism of the Nymex WTI contract as a global benchmark, Bob Levin, managing director of energy and metals at Nymex, was quoted saying the Cushing complex has 47.5 MMbbls of storage capacity. We assume that is total capacity. We also assume operational capacity is probably around 10 percent below the total or somewhere in the vicinity of 42 MMbbls.

Therefore, there is still around 20% of capacity remaining at Cushing… based on the assumption capacity is actually 47.5 MMbbls. However, there are a lot of skeptics out there who think total capacity is closer to 40 MMbbls. If that is the case then operable capacity could be as low as 36 MMbbls. That would mean there is only around 2 MMbbls (5½%) of capacity remaining.

Either way, there is still room at Cushing, but the market is paying handsomely to potentially test capacity at the Hub. In the meantime, the glut at PADD II is undoubtedly adding pressure to the relationship between Brent and WTI. The June Brent contract jumped to a premium to WTI last week. The current spread is inconsistent to quality specs for the two contracts.

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Be that as it may, as we saw in 2007 (see the Chart of the Day in today’s issue of The Schork Report), just because a market is trading inconsistently to historical metrics does not mean it cannot stay that way longer than you can remain solvent.

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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.

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