The market was gloomy in 2016, but OPEC cut provides some hope in 2017

AS DEMONSTRATED with Brexit, the Columbian peoples’ rejection of a peace accord with FARC and the election of Donald Trump as the 45th President of the United States along with Republican majorities in both chambers of Congress, predicting outcomes is no easy task. With the exception of Republicans holding the House of Representatives, forecasters overwhelmingly predicted the opposite outcome to these stunning elections.

Yet price forecasting is a required endeavor for the oil industry, and oil futures are notoriously volatile. Fortunately, the market offers a variety of information that can be captured and studied, and adjustments and corrections can be made to most positions taken in oil futures. As we look into the 2017 horizon, a quick study of key drivers to the price action for West Texas Intermediate futures traded on the New York Mercantile Exchange in 2016 will provide counsel.

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It was a gloomy market in early 2016, with WTI futures plunging to a $26.05 bbl multi-year low in February, as oversupply swamped futures values. Noncommercial traders held the fewest long positions, a bet prices would move higher, in more than 3-1/2 years. Yet, in less than four months, nearest delivered WTI futures would nearly double, topping $50 bbl in May even as global oversupply persisted.

A turnaround in the market’s psychology, aided by historically strong early year gasoline demand was a key factor that rallied WTI futures from winter to late spring. A market follower can capture this data updated weekly by the Commodity Futures Trading Commission in their Commitment of Traders report that can be analyzed with DTN ProphetX software (see screenshots).

The market’s psychology is reflected through the disposition of noncommercial traders who are speculating when buying a futures contract since they are not hedging a physical position in the underlying market. The accompanying chart highlights the frequent incongruities between sentiment and fundamentals, with noncommercial traders adding long WTI positions even though domestic commercial inventory continued to build.

Commercial crude inventory in the United States was drawn down in the second quarter from a late April peak well above 500 million bbl, according to data from the Energy Information Administration. Nonetheless, supply remained at stubbornly elevated levels despite record high implied gasoline demand in 2016 which peaked in June, said EIA. By mid-July, crude stockpiles were again growing, accelerating long liquidation that pressed nearest delivered WTI futures below $40 bbl in early August.

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The summer’s bearishness was also reflected in widening WTI calendar spreads that had narrowed by roughly 80% from the early first quarter to the end of the second quarter on expectations demand growth would overtake new supply and gradually whittle down bloated inventory as low market prices took their toll on production activity. Indeed, US crude production dropped to a 26-month low in ending June. However, domestic output edged higher, although sporadically, into the fourth quarter before making substantial gains in November, as WTI futures traded on either side of $50 bbl in October.

The contango widened in the summer with the production gains, illustrating bearishness driven by fundamental factors. However, market sentiment again changed in August, and abruptly, as talk by the Organization of the Petroleum Exporting Countries to reinstate a production quota previously jettisoned in 2014 prompted short covering after the mid-summer selloff.

For nearly four months, the market was enslaved by what action OPEC would take on production, last cutting their output eight years prior. The market had its qualms that OPEC would actually reach an accord to tighten their production, having failed to act on multiple occasions earlier in the year amid member combativeness, and again unwound long positions. However, a pledge reached in late September in Algiers ended the selloff, and rallied the WTI contract amid renewed bullish sentiment to a 15-month high in October.

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While ending September with a pledge to reduce production, details on terms, including individual member quotas were to be determined ahead of OPEC’s biannual summit in Vienna on November 30, sparking jockeying among the 14 members for terms that often fulfilled their self-interest. OPEC members pumped at a record production rate of 33.83 million bpd in October, according to the International Energy Agency, casting doubt that the producer group would reach an agreement.

The disharmony between word and action soured the market, again triggering long liquidation by noncommercial traders as market sentiment turned bearish, driving nearest delivered WTI futures to a multi-month low in mid-November.

As experienced in early August and late September, increasing bearish bets sets the market up for a short covering rally. WTI futures spiked more than 8.5% on November 30 in an initial reaction to an OPEC agreement to cut production by 1.2 million bpd beginning in January 2017. Market sentiment was again turning bullish.

As we peer into 2017, the OPEC agreement should provide price support for WTI futures. However, analysts note higher crude values will prompt increased production, notably by US shale oil producers, that diminishes the agreement’s bullishness. That leads us to WTI’s forward curve which remains under $60 bbl for the next several years, as the accompanying chart illustrates. Keep an eye on long-dated deliveries for clues on an evolving shift in sentiment, cutting through the market’s noise with DTN ProphetX.

Trump and the US Biodiesel Market in 2017

Article by Brian L. Milne, Energy Editor, Product Manager with Schneider Electric

The surprise election of Donald Trump as the 45th President of the United States has sparked concern that the 10-year old Renewable Fuel Standard might come under attack by his administration despite Trump’s repeated comments during his campaign and after his November win that he supports ethanol in US transportation fuel. Ethanol is the primary renewable satisfying the RFS, with biomass-based diesel the second largest contributor in meeting the mandate.

The RFS has several nested categories including cellulosic fuel. The renewable industry’s failure in producing enough cellulosic fuel to meet the mandate—or should we assign blame to unrealistic legislators in setting the target too high—has allowed the RFS to come under criticism.

The high volume requirement for the renewable fuel nested category, overwhelmingly satisfied by corn-based ethanol, is another area of protest against the RFS. The increasing volume required to satisfy this portion of the RFS can’t be met with E10 alone, a 10% concentration of ethanol in gasoline, while restrictions remain for a higher concentration for conventional fuel vehicles. Meanwhile, flex-fuel vehicles that allow for a variety of higher ethanol blends in gasoline have only modestly added to US ethanol consumption.

This reality has triggered adjustments to the statutory volume mandates under the RFS, and also spiked costs for many of the oil refiners that are obligated to meet the mandate through their purchase of Renewable Identification Numbers—the credit used to show compliance with the RFS. RINs, which are generated with the renewable and move through the supply chain with the blendstock, can be separated and sold in the open market. RIN values surged in 2016 in a repeat performance from 2013 when ethanol neared the 10% “blend wall,” prompting the US Environmental Protection Agency to downgrade the volume requirements under the RFS.

Biomass-based diesel, primarily biodiesel made from soya oil, fats and grease while renewable diesel volume continues to increase, has largely been shielded from these criticisms. Indeed, biomass-based biodiesel has moved into the breach, covering volume shortfalls in other nested categories to more closely align annual RFS volume obligations issued by the EPA with the statute.

On November 23, 2016, EPA, the administer of the RFS, finalized 2017 volume requirements for obligated parties—oil refiners and importers of petroleum-based transportation fuels—that remain below statute level, although above their proposal issued earlier in the year in May.

For 2017, the total renewable fuel volume requirement is 19.28 billion gallons, 2.6% above the 18.8 billion gallons proposed in May 2016, while 19.7% less than the 24.0 billion gallons stated in the statute. For biomass-based diesel, the final renewable volume obligation remained as proposed at 2.0 billion gallons and at 2.1 billion gallons for 2018, the only nested category with the RVO determined for 2018. This is well above the 1.0 billion gallons stated in statute that’s the minimum annual RVO for biomass-based diesel since 2012.

American Petroleum Institute President and CEO Jack Gerard reiterated the trade association’s position to end the RFS, saying at API’s annual luncheon on January 4 in Washington, DC, “repeal it, or significantly reform it.” He suggested a cap on ethanol content in gasoline at 9.7% which has previously been proposed in the US Congress would satisfy concerns by the oil and gas trade group.

API highlighted how the US energy landscape has changed since the current RFS—the first RFS was enacted in 2005— was passed into law as part of the Energy Independence and Security Act, with the United States moving from energy scarcity to a potential position as net-energy exporter. The trade group said US crude oil and natural gas resources are 63% higher than forecast by the Energy Information Administration when the current RFS was passed into law. Demand for refined fuels is also below EIA projections with US gasoline demand 10% lower than what was forecasted 10 years earlier.

“As we approach the 10 percent ethanol threshold in our fuel mix, which could mean substantial economic harm to American consumers, it is imperative that Congress revisit this broken RFS policy,” said API in their “2017 State of American Energy.”

The price of RINs were volatile in November and December 2016 following the election of Trump, tumbling in mid-November on the uncertainty of what his presidency means to the RFS before rallying in response to the EPA’s finalized 2017 volume requirements and sentiment Trump won’t change the program.

However, several of Trump’s nominees for positions in his administration have been critics of the program, triggering selloffs in the RIN market. They include Oklahoma’s Attorney General Scott Pruitt, nominated to head the EPA, an agency he has legally challenged on several occasions. Former Texas Governor Rick Perry who has been nominated as head of the Energy Department, a department he said in 2012 he would eliminate if president during a failed run to win the Republican nomination. In 2008 as the governor of Texas, Perry petitioned the EPA for a 50% waiver of the RFS volume requirements because enacting the full RFS would cause “severe economic harm,” which was denied by the EPA.

Trump chose billionaire Carl Icahn to be a special advisor on rationalizing regulations. Icahn, a majority owner of an independent oil refiner, famously opined in an editorial in 2016 that Pablo Escobar, the now deceased Columbian drug lord, would have found speculating in the RIN market more profitable than trafficking cocaine. Independent refiners that lack blending capacity have seen profits evaporate because they must purchase RINs.

However, Iowa Governor Terry Branstad, an ardent supporter of the RFS and Trump’s choice to be the US ambassador to China, has said Trump continues to support the RFS, calming the renewable fuels industry to a degree.

Adding to the worry for the biodiesel industry is the lapse of a US$1.00 tax credit paid to blend biomass-based diesel into petroleum-based diesel, which expired on the last day of 2016. This credit has been a critical bridge between higher costing biodiesel and petroleum-based diesel, and the uncertainty on whether it would be extended into 2017 greatly limited trading for forward physical deliveries through the later part of 2016.

“There is a clear correlation between the tax incentive and increased biodiesel production, which has grown from about 100 million gallons in 2005, when the tax incentive was first implemented, to a more than 2.5 billion gallon market in 2016,” said Anne Steckel, vice president of Federal Affairs for the National Biodiesel Board in a news release. “With less than a decade of commercial-scale production, biodiesel remains a young and maturing industry that needs stable, long-term tax policy to continue meaningful growth.”

Considering Trump’s plan to close tax loopholes and expectations Republicans, which control both the Senate and the House of Representatives, would rewrite the US tax code there is speculation that this credit won’t be reinstated. If this assessment is correct, spot transactions could remain constrained, although imports would likely decline.

Scott Irwin and Darrel Good with the Department of Agricultural and Consumer Economics at the University of Illinois contemplated the “push” for the advanced biofuels nested category within the RFS due to the shortfall in the cellulosic nested category, with the write down greater than for advanced biofuels.

“That difference is 520 million gallons in 2017, much larger than in the previous two years,” they wrote in their farmdoc daily on December 7, 2016. “An important issue with regards to future implementation of the RFS, then, is the magnitude of the advanced mandate push, if any, under a new Administration.”

In addition to the biomass-based diesel nested category, biodiesel can be counted against the advanced biofuels mandate. EPA set the final demand requirement for advanced biofuels in 2017 at 4.28 billion gallons, 7% above its May 2016 proposal of 4.0 billion gallons, while less than half of the statute’s 9.0 billion gallons for this year.

In their analysis under multiple scenarios, Irwin and Good sets implied demand for biomass-based diesel at 3.083 billion wet physical gallons in 2017 that could decline to 2.883 billion gallons in 2018 or increase to as high as 3.363 billion gallons depending on how the Trump administration addresses the RFS. By 2022, the year when volume increases under the RFS end, biomass-based diesel demand could range from 3.316 billion gallons to 4.329 billion gallons.

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“[W]hile annual production of and consumption of biomass-based diesel and its feedstocks will likely increase substantially by 2022 in order to fulfill the advanced mandate, the magnitude of the increase could vary over a wide range depending on how much of the cellulosic mandate is effectively converted into additional biomass-based diesel mandate,” said Irwin and Good.

In their most recent Short-term Energy Outlook, the EIA projects distillate fuel consumption to grow 1.5% to 3.94 million bpd in 2017 after dropping 3% to 3.88 million bpd in 2016 and 1% to 4.0 million bpd in 2015. The projected pickup in demand comes alongside expectations for quicker economic growth in the United States in 2017, with the latest data available from the US Bureau of Economic Analysis estimating a 3.5% annualized growth rate for the US economy in the third quarter 2016—the greatest quarterly expansion in two years.
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In the United States, growth in diesel demand correlates closely with an expanding economy since diesel is primarily used in commercial and industrial settings.

Freight movements in November 2016 suggest the trend continued into the fourth quarter, with the Am
erican Trucking Associations’ advanced seasonally adjusted For-Hire Truck Tonnage Index climbing 5.7% from year prior.

“While I think the November gain overstates the strength in the freight markets, I do believe we are seeing some improvement that will continue into 2017. Retail sales are good, the housing market is solid, and the inventory overhang throughout the supply chain is coming down, all of which will help support truck freight volumes in 2017,” said ATA Chief Economist Bob Costello.

Trucking serves as a barometer of the US economy, representing 70.1% of tonnage carried by all modes of domestic freight transportation, including manufactured and retail goods.

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Gasoline Futures Surge 12% in December to New High

Article by Brian L. Milne, Energy Editor, Product Manager with Schneider Electric

The gasoline futures contract traded on the New York Mercantile Exchange surged 12% in December, with reformulated blendstock for oxygenate blending futures establishing a new calendar year high for 2016 at $1.7038 gallon between the Christmas and New Year’s Day holidays. Gasoline futures outpaced the advance by West Texas Intermediate and ULSD futures in December which both rallied 9%, as bullish sentiment took control of the market.

Spurring the market’s bullish psychology were agreements to reduce production by the Organization of the Petroleum Exporting Countries on November 30 joined by a companion pact on December 10 when 11 non-OPEC producing countries also agreed to cut output. Combined, the two agreements call for a 1.758 million bpd cut in production that, if adhered to, would push global oil demand over production midyear, according to several analysts including the International Energy Agency.

The agreements took effect January 1 and are for six-month terms, although country commitments call for an average at the quota level to be reached by June, so some production cuts might not start right away. This feature could puzzle analysts during the interim as they scrutinize monthly production data for compliance, likely sparking increased price volatility.

Noncommercial traders, also known as speculators since they are not using a futures contract to underpin a physical position in the underlying market, covered short positions and accumulated long positions in NYMEX RBOB futures in reaction to the November 30 agreement. A long position is taken on expectation prices would move higher over time.

A rebalancing market will still need to contend with an abundant quantity of oil in inventory. However, the production cuts would gradually chop down the mountain of supply that has grown over the past couple of years and, in turn, underpin a higher global oil price.

This expectation was lent support late in 2016 on a string of data suggesting a quicker expansion of the US economy in 2017, with the Bureau of Economic Analysis in late December reporting a 3.5% annualized growth rate in US gross domestic product for the third quarter 2016–the largest quarterly expansion in two years. Greater economic activity consumes more oil.

The US Federal Reserve lifted the federal funds rate in December for only the second time in 10 years on evidence it finds supporting a stronger US economy that, in large part, propelled the US dollar to a 14-year high. Consumer confidence in the United States reached a12-year high in December, with a new administration in Washington, DC, seen creating broader economic opportunity.

A confident consumer is willing to spend more of his or her hard earned currency which bodes well for fuel retailers. As we look at RBOB futures forward curve, we see an increasing premium built into gasoline prices in early 2017 which reach the mid to upper $1.80 gallon range in April, May and June.

Climbing gasoline prices could erect a speed bump to higher sales volume for retailers and suppliers alike in 2017 should demand slow, as witnessed in in late 2016. Although implied gasoline demand set a record high in 2016, demand slowed late in the fourth quarter against the comparable year-ago period as gasoline prices gained.

EIA data shows during the four-week period ended December 23, gasoline supplied to market averaged 9.045 million bpd that, while a strong reading, trailed the same four weeks in 2015 by 260,000 bpd or 2.8%. For the year through December 23, implied gasoline demand averaged 9.367 million bpd, up 211,000 bpd or 2.3% against 2015.

The US average for regular grade gasoline sold at retail outlets reached a six-month high of $2.364 gallon on December 26, according to EIA data, 32.5cts above year prior. The lower price point in late 2015 was seen incentivizing demand.

In a recent note to clients, Tim Evans, futures specialist with Citi Futures, highlighted gasoline demand’s response to prices, saying, a decline in gasoline prices in 2015 lent support to demand with growth up as much as 3.4% in the 12 months ended in September 2015.

“Since then we’ve seen a slowing to 2.0% growth in the 12 months through September 2016. Looking ahead to next year,” said Evans on December 22, “we would not be surprised if growth slows to something more like 1.0-1.5%, a more sustainable pace in our view.”

Gasoline exports from the United States, which are included in the products supplied statistic, surged in 2016, reaching a weekly record high of 1.1149 million bpd in late December. Moreover, the trend looks sustainable, as US refineries produce more gasoline than needed by the domestic market amid the country’s oil and gas renaissance.

Much of those exports have been shipped to Mexico, where growing domestic consumption joined refinery constraints and outages to spur the demand for US barrels. Mexico is gradually liberalizing its gasoline market, including on imports, which would aid US refineries that are producing well above their historical average.

To learn more about Schneider Electric’s energy and commodity trading platform, DTN ProphetX click here.