THE INCONVENIENCE OF OIL

For the first time in three years, oil inventories in the United States are not rising precipitously more than the seasonally expected. At the start of both 2015 and 2016, oil stocks exploded higher as oil prices crashed, all related to the “dollar” flex on the front end of the futures curve creating sufficient contango necessary to strip that oil from upfront usage. With no immediate “dollar” threat in 2017, oil conditions can go back to normal seasonality with one vital exception; the inventory builds of the past two years remain. All that has changed is the new amount added to the stillexisting “glut.”

That’s why, as noted, it will be difficult for oil prices to more fully embrace “reflation” in a way that other asset classes have already. Before things can truly go back to normal, something must be done about what happened over the past few years. “Reflation” is mostly about what could happen tomorrow, but oil, in particular, can’t just ignore yesterday. For the most part, it hasn’t. The WTI futures curve, for example, has found an eerie sort of stability pegged at around $55, with mild backwardation in the middle. That suggests, strongly, oil investors don’t expect oil to go much above that level for quite some time. With the familiar “hook” in the front end of the curve, the risks remain still to the downside.

It is in many ways a remarkable state, though not wholly an unexpected one. Downstream of crude is gasoline and a more direct economic relationship. Unlike crude, however, gasoline inventory is sharply higher to start 2017 just as it was to start 2016. That is a serious and somewhat alarming circumstance given that the beginning of last year was bordering on recession.

Further, gasoline flow-through rates have fallen compared to late 2015, meaning that there is less going in to gasoline inventory and still not nearly enough coming out of it. Supply has dwindled somewhat, but still not enough to match demand that remains in the same state of weakness.

There was some of the optimism provided by the equalization potential that you can see in the chart immediately above; where in 2016 the cutback in the supply of distillates like gasoline after August appeared to be working in addressing the demand shortfall after the huge disparity to start the year (again, under conditions near recessionary). To repeat the outsized inventory accumulation again to begin 2017 shows that, like crude oil, nothing has changed in macro terms apart from diminished supply (negative economy).

[Jeffrey Snider – Seeking Alpha]