There are two key takeaways from the recent market performance. The first one is that central banks’ action is not es effective as hoped and the second one is that the coronavirus epidemic is likely to have a longer-term negative effect on the global economy and oil demand. After the Fed announced its surprise 0.5% rate cuts on Tuesday the US stock markets tumbled. Investors are of the view that the epidemic cannot be halted by monetary measures. Although Tuesday’s losses were more than reversed yesterday it was down to the fact that the Democratic race for the upcoming US election has been thrown wide open. Joe Biden produced a spectacular come back on Super Tuesday and currently is the favourite to challenge Donald Tump in November. Michael Bloomberg has dropped out of the race and endorsed the former vice president. It is now basically a two-horse race between Mr Biden and the left-leaning Bernie Sanders, whose possible nomination would send shivers down investors’ spine. Yesterday’s rally is seen as a welcome correction before concerns about the health of the global and US economy return to the forefront.

The central bank of the oil market, OPEC, has also failed to lend optimism. As ministers have gathered in Vienna to thrash out the details of the next production cut they ran into resistance from Russia. The world’s second biggest oil producer has reportedly opposed the Saudi proposal of deepening the supply cut by an additional 1.2 mbpd taking the total to 3.3 mbpd including the voluntary reduction of 400,000 bpd from Saudi Arabia. An agreement to reduce the OPEC+ group output level by at least 1 mbpd is imperative otherwise oil prices will re-visit the recent lows and possibly break below them.

Such a scenario is absolutely plausible as the virus has not been contained. Italian cities have become ghost towns, schools and universities are shut down and sporting events are to be played in empty stadiums. The governor of California has declared state of emergency due to the growing number of confirmed cases, which jumped to 53. South Korea reported 438 new cases yesterday. No wonder that Brent gave up all its early gains and settled at $51.13/bbl, 73 cents/bbl lower on the day. Its structure has weakened significantly and the European benchmark is now displaying contango all the way down the curve.

Not even an extremely bullish EIA statistics was able to boost morale. A fall of 1% in refinery utilization led to draws of over 4 million bbls both in distillate and gasoline inventories whilst crude stocks built less than expected (784,000 bpd). Total commercial inventories fell nearly 12 million bbls and combined crude and products net exports hit an all-time high of 1.5 mbpd. However, both WTI and Heating Oil lost value over the day and only the RBOB contract managed to climb higher.

NYMEX cracks are strengthening but…

Ever since the coronavirus has triggered serious concerns about global economic growth investors have been shunning risky assets. Stock markets have been in a free fall for the better part of the past month and oil joined the bears’ party. Brent shed almost 30% of its value between January 20 and March 2, before OPEC and central bank-induced (false) retracement has begun. During this downturn money managers and financial investors were getting rid of everything that could potentially be negatively impacted by the epidemic. Net speculative length (NSL) in Brent, for example, was reduced from 428 million bbls in the week ending January 21 to 288 million bbls during the last reporting period ending February 25. Front-month Brent weakened nearly $10/bbl in these 5 weeks. WTI NSL was down by 126 million bbls with the price falling roughly the same as Brent.

During the latest week, however, the strangest phenomenon emerged. NSL in the two main crude oil benchmarks rose by a combined 35 million bbls (30 million in WTI and 5 million bbls) yet futures prices tanked more than $2/bbl during the week. When NSL falls price usually follows suit. Although it is not set in stone, but a more then $2/bbl weakness in crude oil futures that is coupled by an increase of 9% in NSL is almost unprecedented.

One obvious explanation for this anomaly would be increases in net long positions of producers. This, however, was not the case last week as WTI producers cut their length by 25 million bbls and Brent producers increased their net short exposure by 37 million bbls. The explanation lies with products. NSL was cut or NSS (net speculative short) increased in all three categories last week. Money managers in Heating Oil futures upped their net short positions by 10 million bbls. RBOB NSL declined by 5 million bbls and is now 14 million bbls below the end-January level. Gasoil speculators cut their exposure by 14 million bbls last week or 66 million bbls in total since January 21.

These reductions are reflected in the assorted crack spreads. NYMEX Heating Oil/WTI, RBOB/WTI and the 3-2-1 crack spreads all weakened during the latest week with the latter falling below $40/bbl by the end of last month from over $50/bbl in the middle of February. The Gasoil/Brent price differential dived below $8/bbl last week. Although there has been a remarkable comeback in these spread values over the past few days, greatly assisted by the yesterday’s EIA stats this strength is unlikely to last.

The preceding weakness in futures spreads and the consequent exit from speculative positions have a justified fundamental explanation. As the virus outbreak started to paralyze the Chinese economy expectations were rising that refiners that stockpiled products for domestic use would be forced to look for export markets for their commodities creating oversupply. These expectations are slowly turning into reality. Consultancy FGE forecasts a significant rise in Chinese product exports, especially in gasoline. The consulting firm foresees a jump to 460,000 to 530,000 bpd in gasoline exports this month breaking above the recent monthly high of 520,000 bpd. The trend is expected to continue in April as domestic demand will remain subdued in coming months. Gasoline cracks are set to weaken further in the immediate future and the same goes to jet fuel and diesel. Singapore jet fuel flirted with the $4/bbl level against Brent last week whilst Far Eastern diesel margins have also hit their lowest levels for almost two years. The protracted weakness in Asian refining margins should have a knock-on effect on related crack spreads in other parts of the worlds, including the US in coming months.