United States Petroleum January 28, 2017

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1 United States Petroleum January 28, 2017 Background U.S. petroleum, crude and refined, transitions from a negative seasonal trend in late December to positive seasonal trend in late January and early February. The transition to seasonal strength last year was initiated from multi-year lows, associated with inverse correlation to the Dollar Index, and bullish underlying market structure as measured by the Commodity Futures Trading Commission Commitment of Trader s Data. This year s seasonal transition occurs under different circumstances after price nearly doubled last year primarily driven by OPEC rhetoric. NYMEX Light Sweet Crude Oil Futures now exhibit record positive correlation to the Dollar and record bearish market structure. Additionally, crack spreads are narrowing during a season they should be widening. These factors contrast with generally positive price trends following last year s price increases. This analysis will explore these issues for both NYMEX Light Sweet Crude Oil (CL) and NYMEX NY Harbor Ultra Low Sulfur Diesel (ULSD) Futures (HO). ULSD often leads CL during transitions and currently has a more bearish technical outlook. Blacklion Capital Management Page 1 of 18

2 Seasonal Trend The petroleum complex typically declines after Fourth of July into Christmas, consolidates at the beginning of the year, and then trends higher from the end of January into summer. The top pane of Chart 1 is a non-roll adjusted continuous price contract/index of CL and the bottom pane is a 10-year weighted average of annual seasonality of the same. All seasonal trend analysis herein is constructed similarly. Chart 1 CL Seasonal Trend; CME Group NYMEX; esignal, Updata CL reversed up from multi-year lows beginning February last year, climbed with its seasonal trend into summer consolidation in Chart 1. Consistent with seasonal trend price began to decline after Fourth of July, but the downtrend reversed sharply on expectations that OPEC would institute production limits. CL was very volatile and ended the year near its annual high counter the seasonal trend The rhetoric driven price increase chased higher by speculators offered commercial participants, primarily producers, the opportunity to hedge at higher prices. This leads to record bearish market structure we will explore later. Blacklion Capital Management Page 2 of 18

3 Consistent with CL breaking its seasonal trend during H ULSD also trended higher in the latter half of the year contrast with its typical second half seasonal weakness in Chart 2. Chart 2 ULSD Seasonal Trend; Source: CME Group NYMEX, esignal, Updata The rise in ULSD during the latter portion of the year also offered opportunity to hedge prices driving a bearish market structure against a backdrop of positive trending prices. Now is typically the time of year we would expect petroleum prices to begin increasing given the 10year weighted average seasonal trend in Charts 1 & 2, but the action that got us here, nearly doubling prices in a year, leaves us with fewer buyers to bid the price higher and abnormal Dollar correlation. Blacklion Capital Management Page 3 of 18

4 Dollar Index (DX) Correlation Crude oil and its refined products are internationally fungible Dollar denominated commodities. Dollars are represented here by the DX whose futures trade on Intercontinental Exchange (ICE) U.S. Historically and intuitively there is an inverse correlation between CL and DX, i.e. when the DX rises CL should decline all else equal. Historical correlation between these two instruments measured by their correlation coefficient (R) is -80 or -0.8 depending on how calculated. Analyzing R for shorter time frames reveals correlation may shift, sometimes dramatically, but that it quickly reverts toward its long term historical relationship. Short term analysis examines correlation coefficient for 65 trading days, approximately 90 calendar days, in Chart 3. Chart 3 CL DX 65-day Correlation; Source: CME Group NYMEX, ICE (US), esignal, Updata The top pane is the same continuous contract/index for CL examined earlier, the green line is the DX, and the bottom pane is the 65-day correlation coefficient, R. Two things merit consideration in Chart 3. R occasionally turns positive reaching up to 50 and quickly reverts to historical norms. The past four (4) months correlation has persisted positive. R set a near-term record ~55 in July 2014 before CL declined from more than $100 to below $40 before the short-term R value turned positive again. R is now above 65. Persistent positive correlation does not solely mandate a reversal, but price trend reversals often occur at extreme levels of counter historical correlation. Blacklion Capital Management Page 4 of 18

5 Market Structure The fundamentals of commodity futures market structure is presented here. If you are familiar with this information this section may be skipped. Commitment of Traders The Commodity Futures Trading Commission (CFTC) collects the Commitment of Traders (COT) data each Tuesday and disseminates it Friday afternoon. The report documents positions according the three classification of traders: Commercials Commercial participants produce, consume, or otherwise handle petroleum in their primary business. Their participation in the market is to hedge price exposure either as producers selling the commodity, consumers refining it, or other enterprises involved in the trade of physical petroleum. Commercials are the best-informed market participants due to their exposure to dealing in the physical commodity and their net positions are primary indicators of future market direction. Large Speculators Speculators are funds, institutions, and/or well capitalized individuals taking large positions long or short in a commodity trying to profit from a move in price favorable to their position. They are typically well versed in the industry, but lack the direct physical exposure of the commercials. Additionally, speculators tend to be trend followers often adding to their positions as trends get extended. Their net position when extreme is a contrary indicator. Non-Reporting Speculators Non-reporting traders are typically individuals trying to profit from directional moves like large speculators. Of the three classifications, non-reporting traders are the least informed and analyzed as a contrary indicator. Analysis COT data may be broken down into 3 portions: long, short, and net where net is long minus short. The data is most useful when net positions reach extremes. Commercials are used as primary indicators and speculators and non-reporting traders as contrary indicators. Additional consideration is given when both speculators and non-reporting traders are similarly positioned on the same side of the market opposite commercials s rise in petroleum prices was supported by large speculators, primarily trend following funds, increasing long and net long positions. OPEC rhetoric motivated higher prices in the second half and trend following speculators reached record long positions in CL and ULSD. Commercial participants used the second half counter seasonal trend increases to sell into higher prices hedging price risk enabling additional exploration and/or production activity with a stable financial outlook. Blacklion Capital Management Page 5 of 18

NYMEX Light Sweet Crude Oil Market Structure Charts in this section are constructed the same. Top pane is weekly price data of the continuous contract/index.

6 NYMEX Light Sweet Crude Oil Market Structure Charts in this section are constructed the same. Top pane is weekly price data of the continuous contract/index. Commitment of Traders data is published Friday afternoon so weekly price data is appropriate. Second, green, pane is long positions (futures + options) for the classification of trader. Third, red, pane is short positions (futures + options) for the classification of trader. Bottom pane is net position (long minus short) for the classification of trader. Commercial Commercial participants in crude oil are near record short and record net short in Chart 4. Chart 4 CL Commitment of Traders - Commercial; Source: CME Group NYMEX, CFTC, esignal, Updata Producers increased short positions as prices increased from the February 2016 nadir below $30 while those hedging crude oil input longs were relatively stable such that today commercials are record net short in the bottom pane of Chart 4. The last time the net short position was near this level was summer 2014 before CL prices declined more than 50%. The ability of producers to hedge price risk at these levels and across the NYMEX forward curve helps ensure the viability of additional exploration and production at least partially insulated from price risk. Blacklion Capital Management Page 6 of 18

7 Large Speculators Large speculator s positions in CL are detailed in Chart 5 below. Chart 5 CL Commitment of Traders - Large Speculators; Source: CME Group NYMEX, CFTC, esignal, Updata From 2016 s low large speculators increased long positions to record levels while simultaneously reducing short positions such that they are now record net long; 9.8% more so than at the previous July 2014 record before CL s precipitous decline. Large Speculators are trend followers that have driven the market higher. In a correction speculators will be forced to offset the net long positions because they do not have the ability, interest, and possibly capital to take physical delivery. At record levels of long positions, it is important to ask/consider: who is left to buy and sustain the positive trend? NYMEX Light Sweet Crude Oil Market Structure Summary Commercials are the best-informed market participants and they are record net short indicating a bias for lower prices. Speculators are record net long and limited in ability to push the market higher. Blacklion Capital Management Page 7 of 18

8 NYMEX Ultra Low Sulfur Diesel Market Structure ULSD often leads CL in trend changes and appears to be doing so again. The market structure for ULSD is reversing, while CL is still extending though at record levels. Commercial Commercials achieved record short and net short positions the first week of January in Chart 6 below. Chart 6 ULSD Commitment of Traders - Commercial; Source: CME Group NYMEX, CFTC, esignal, Updata Since reaching record levels commercials have eased their long, short, and net short positions consistent with the decline in ULSD. This is classic behavior when the commodity has put in a near term high that will be more evident in the technical analysis portion of this report. Blacklion Capital Management Page 8 of 18

9 Large Speculators Large Speculators were record long and net long in Chart 7 in early January. Chart 7 ULSD Commitment of Traders - Large Speculators; Source: CME Group NYMEX, CFTC, esignal, Updata Since reaching the peak prices have declined gradually as speculators moderated long positons and gradually increased short positions reducing net short positions from the record set weeks earlier. This is classic behavior when the commodity puts in a near term high. Blacklion Capital Management Page 9 of 18

10 Crack Spreads Crack spreads are approximations of the yield of refined products from cracking/refining crude oil. They can be simplified financially by comparing the difference between similar dated, front-month, futures for refined products (gasoline and ULSD) and NYMEX Light Sweet Crude Oil futures adjusted for gallons/barrels. Subtracting CL from either ULSD or NYMEX RBOB Gasoline Futures (RB) roughly approximates the gross profit from refining represented in front month futures settlement. These spreads may be referred to as 1-to-1 (1:1) crack spreads rather than the 3:2:1 crack spread that represents the yield of refining 3 barrels of crude oil into 2 barrels of gasoline and 1 barrel of ULSD. ULSD Crack Spread The 1:1 ULSD crack spread is detailed in the top pane Chart 8 with the 10-year weighted average of annual seasonality in the bottom pane. Chart 8 ULSD 1:1 Crack Spread; Source: CME Group NYMEX, esignal, Updata The annual seasonality for this crack spread demonstrates that it should begin to widen at the start of each year. Counter that trend the crack spread has narrowed considerably in 2017 as ULSD storage set a record this month. The narrowing crack spread indicates ample supply of crude oil input, ample supply of ULSD, soft demand for ULSD, or a combination of those factors that is weighing on ULSD prices and ultimately will weigh on the demand for crude oil. Blacklion Capital Management Page 10 of 18

11 RBOB Gasoline Crack Spread Similar to the ULSD crack spread the 1:1 RBOG Gasoline crack spread in Chart 9 is narrowing. Chart 9 RBOG Gasoline 1:1 Crack Spread; Source: CME Group NYMEX, esignal, Updata Like the ULSD situation the 10-year weighted average of annual seasonality predicts the spread should be widening and it is narrowing and near the lower portion of its historical range. Gasoline storage has not set a record, but is sharply increasing faster than its historical 5-year average growth rate for this time of year. Crack Spread Summary Narrowing cracks spreads indicate declining gross profitability for refined products and may lead to slack demand for crude input. Slack demand and excess supply of ULSD is already evident in ULSD s weakening price and it often leads petroleum market trend reversals. Blacklion Capital Management Page 11 of 18

12 Technical Analysis Price analysis reveals what is occurring to narrow the 1:1 ULSD crack spread. CL prices are technically more positive, but it is challenged by more bearish market structure and the specter of slackening demand from narrow crack spreads as ULSD is already in an intermediate negative trend. NY Harbor Ultra Low Sulfur Diesel ULSD daily trend is positive in Chart 10 with price and the lagging line both above positive (light blue) cloud spans. Chart 10 ULSD (HO 'F=1) Continuous Daily; Source: CME Group NYMEX, esignal, Updata However, ULSD is correcting after the bearish reversal pattern in the yellow oval that corresponds to the market structure reversal in Charts 6 & 7. Blacklion Capital Management Page 12 of 18

13 Point and figure analysis in Chart 11 is consistent with daily Chart 10. Chart 11 ULSD (HO 'F=1) Continuous Daily; Source: CME Group NYMEX, esignal, Updata ULSD is trading in a new positive trend above bullish support and five (5) intermediate bullish support trend lines. There are three active positive price targets the nearest of which is 9% higher. ULSD is resting on intermediate support at $1.614, but intermediate term analysis details a correction. Blacklion Capital Management Page 13 of 18

The same data on 60-minute point and figure analysis reveals deteriorating prices and helps explain why the refined product is weaker than the crude input and narrowing the crack spread.

14 The same data on 60-minute point and figure analysis reveals deteriorating prices and helps explain why the refined product is weaker than the crude input and narrowing the crack spread. Chart 12 ULSD (HO 'F=1) Continuous 60-Minute; Source: CME Group NYMEX, esignal, Updata ULSD peaked on January 3rd above $1.75 realizing all active positive targets coincident with the reversal pattern on the daily chart. ULSD made a series of lower highs testing support at $1.610 and generating four (4) negative price targets two (2) of which have been realized, $1.638 and $ There are two more active negative targets 2.9% and 7% lower. Realizing the next negative target on the 60-minute time frame breaks intermediate support on the daily point and figure chart. Additionally, price below $1.60 will activate another negative target further confirming the negative intermediate trend. Blacklion Capital Management Page 14 of 18

15 NYMEX Light Sweet Crude Oil The chart of CL is like ULSD with price and lagging line above positive cloud span in Chart 12. Chart 13 CL (CL 'F=1) Continuous Daily; Source: CME Group NYMEX, esignal, Updata CL printed a negative reversal pattern, yellow oval, consistent with the reversal in ULSD setting a near term high and resistance at $55. Blacklion Capital Management Page 15 of 18

16 Similar to ULSD oil is trading in a new positive trend in Chart 14. Chart 14 CL (CL 'F=1) Continuous Daily; Source: CME Group NYMEX, esignal, Updata There are four (4) active positive targets and a single negative active price target to $49.41 below intermediate resistance. Blacklion Capital Management Page 16 of 18

17 The 60-minute point and figure chart of CL is positive trend with an equal number of active positive and negative price targets. Chart 15 CL (CL 'F=1) Continuous Daily; Source: CME Group NYMEX, esignal, Updata The 60-minute analysis of CL is more positive than ULSD and consistent with the narrowing crack spread; ULSD declining more than CL narrowing the spread. ULSD historically leads trend changes in petroleum. If either of the negative targets on the 60-minute point and figure chart of CL are realized it will reverse the trend and begin to negate the positive targets. The bearish reversal pattern on the daily chart is resistance at $55 also evident on the 60-minute point and figure chart. Blacklion Capital Management Page 17 of 18

18 Summary January February petroleum transitions to positive seasonal trend. This year the transition is taking place in an environment of record positive short-term Dollar correlation, record bearish market structure, and narrowing crack spreads. The run up in crude oil from OPEC rhetoric is evident in the daily technical analysis of both ULSD and CL. However, intermediate term ULSD is negative and often leads petroleum complex reversals. Record long speculators and extreme Dollar correlation favor a correction and the daily high on the January 3rd daily chart reversals serve as resistance. DX Light Sweet Crude Oil Record NY Harbor ULSD N/A Commercial Short Short Speculator Long Long Crack Narrow Narrow Daily Trend Int. Trend Blacklion Capital Management Page 18 of 18

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