An unusual disconnect has emerged in the U.S. oil market, with headline futures slumping to levels below $90 a barrel even as traders in the physical crude market report surprisingly robust demand and strong pricing.
In New York and London, big funds and speculators have turned very bearish on prices due to signs of weakening demand in China and Europe, steady exports from Iraq and Libya and a rallying dollar.
U.S. futures have fallen 17 percent since mid-June and hit $88.18 per barrel on Thursday, the lowest since April 2013.
Among cash traders in Houston and Calgary, where batches of North American crude are bought and sold for delivery in a month's time based on a premium or discount versus futures, a long-anticipated collapse has failed to materialize.
Instead, differentials from Canada to the Gulf Coast are holding steady or even rising as refiners run at their fastest rate for this time of year in over a decade, buoyed by strong profit margins thanks to cheap production from shale hydro fracturing and record fuel exports.
The split views illustrate a surprising twist in the U.S. "fracking" revolution.
This turn is due largely to U.S. refiners expanding their capacity this year far more than expected. That has allowed them to absorb a larger share of oil from North Dakota's Bakken or the Eagle Ford shale plays in Texas, which is illegal to export and would otherwise swell inventories. This underpins local crudes and forces foreign competitors to cut back, knocking global oil prices.
"The differentials didn't collapse like everybody thought they would," said Daniel Sternoff, senior managing director at consultants Medley Global Advisors. "The U.S. crude market has balanced itself at the expense at the rest of the world."
Traders say the real-world cash crude market often acts as an early indicator of direction for the more-speculative derivatives trade.
Three months ago in Europe, physical markets were tumbling, foreshadowing the current futures slump, even as speculation that violence in Iraq and Libya would reduce supply pushed Brent futures to the highest in a year.
More recently, those speculative funds raced to liquidate positions as an excess of crude accumulated in storage tanks in South Africa and on idling oil tankers off the coast of Singapore. Speculators in U.S. crude oil futures have cut a record net long position in half since June, according to U.S. data.
DIFFERENT DRUMMERS
It is common for physical and futures markets to untie. Futures traders tend to focus on macroeconomic supply risks, like turmoil in OPEC member Iraq, while cash traders rarely react to geopolitical events, but care if a pipeline goes down today.
Today's disconnect comes with analysts saying that only a production cut by Saudi Arabia or OPEC can drain the market's excess oil.
But glut is hardly a factor in U.S. cash markets. Bakken crude in North Dakota is trading at around $4.40 a barrel below benchmark WTI, a sharp recovery from a more than $10 discount a year ago. Light Louisiana Sweet has held steady since March around $3 over WTI. Western Canada Select, which often slumps in winter, is at a 14-month high.
At the same time, benchmark West Texas Intermediate futures have fared better then European Brent. The spread between Brent and WTI was $1.50 a barrel on Friday, near its narrowest since 2010.
"There is definitely a supply glut in the North Sea," said a one senior crude trader. "But, not so much in the U.S."
With healthy profit margins, refiners like Valero and Marathon Petroleum have boosted their capacity by some 600,000 bpd this year, mostly through incremental investments and adjustments, according to Sternoff.
Refinery maintenance season, which typically runs September through November, should have caused an excess of oil in the Gulf Coast. Instead, the market has remained tight. Inventories in the storage hub of Cushing, Oklahoma, are falling, not rising, and remain near their lowest since 2009.
U.S. refiners are only shutting about 345,000 barrels per day of crude capacity for maintenance this autumn, 30 percent less than normal, according to IIR Energy data.
"That's kept Gulf-Coast runs higher than normal and thus, demand for crude is higher too," said Michael Cohen, an analyst at Barclays.
ARBING BRENT-LIKE CRUDES
Although most refiners are now starting to shop for crude delivered in November, when seasonal maintenance will ease and demand for spot crude should get even stronger, the physical market could still tumble.
One reason is the narrowing Brent/WTI spread, which is making it profitable to ship crude across the Atlantic. In the physical market, U.S. Gulf Coast benchmark LLS was at a $1.30-premium over Brent on Friday, versus a $4.50 discount a month ago, presenting an arbitrage opportunity that has already prompted some traders to tentatively book tankers from West Africa. U.S. imports of Nigerian crude fell to zero in July for the first time in decades, but new bookings are being reported.
"Now that Brent's come down, the folks buying LLS will have to wait a second and look," said Sarah Emerson, president at Energy Security Analysis Inc. "They might think, 'Maybe I should buy Brent or something Brent-related'."
At the same time, the healthy margins that have underpinned U.S. refiners' demand are threatening to erode.
The U.S. crack spread, a proxy for refiner profit margins based on the difference between the price of crude and some refined fuels, is unusually healthy for this time of year at around $13.50 a barrel. But it has fallen by $10 since June, and has continued to tumble over the past week as gasoline and diesel prices have plunged faster than crude, Reuters data show.
"We're expecting gasoline cracks to fall quickly at this time of year, so you'll see some of that change in the next few weeks," said a trading source with a U.S. refiner. "Last year, we cut our light sweet runs drastically in November."
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