The Energy Futures Recovery Rally Ran Out Of Steam Tuesday

The recovery rally in energy futures ran out of steam Tuesday, with early gains turning into afternoon losses, and that selling has carried through the overnight session. The whiplash action is putting the charts back in neutral territory short term, while longer term charts still suggest a good chance of more selling before year end. 

U.S. stock markets had their best day in nearly 7 months and the U.S. dollar had its biggest sell-off since July, both of which are often seen as bullish indicators for energy contracts. The correlations between those asset classes has been weak-at-best lately however, and yesterday was another case of energy contracts going their own way in the end, after following the lead of stocks for a couple of hours.

Here’s another theory: One often overlooked indicator of price movements for oil is the spread between 5 year treasury bonds and 5 year TIPs, which is a proxy for inflation expectations. Since some traders use oil and other energy commodities as an inflation hedge, there’s been a strong correlation between the 5 year spread (expectation for inflation) and oil prices. Now that inflation expectations are softening, the passive bid under oil prices for those “inflation hedgers” may also be going away. See Chart below.

Another reason for the whiplash action in ULSD this week was likely the unexpected shutdown of Kuwait’s huge 615mb/day Al-Zour refinery which started production last year and has become a major supplier of diesel to Europe, backfilling for barrels that used to come from Russia. That facility being knocked offline no doubt helped spur the 10 cent price surge Monday, but now that it’s scheduled to be back fully online next week, prices are easing once again.   

The API reported a build in crude oil and gasoline inventories last week of 1.3 million and 195,000 barrels respectively, while diesel stocks drew by 1 million barrels. The EIA will release two weeks’ worth of data at 9:30 eastern as it is back on its normal reporting schedule after a system upgrade. 

Although there have been a rash of unplanned refinery hiccups in the past week stretching across PADD 3, basis values continue to slump and suggest that the return of numerous refineries after the busiest fall maintenance schedule in 4 years is setting us up for a glut of some products. Colonial line space values are also reflecting this reality with both gasoline and diesel values soaring in recent weeks as Gulf Coast producers suddenly seem to be struggling to find options, while East Coast inventories remain relatively tight. 

Already there are reports that some units coming back online may not return at full capacity given the sudden weakness in crack spreads and swelling inventories, particularly for gasoline. 

The NHC is tracking 2 potential storm systems as we reach the last 2 official weeks of Hurricane season. Neither storm looks to be a threat to energy supplies, but it will bring heavy rain to the East Coast and looks like it might put a damper on the typical demand rush heading into Thanksgiving week.

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