Contango

Recently, the Baker Hughes Rig Count has become all the rage. The problem is that not all rigs are created equal, and what we see is still a “net” number. We see the net number of rigs that are working. The reality is that some new projects continue to come on line and are very high producing wells, and some of what is being taken away, was either old, or projects that hadn’t yet been contributing production. While many have pointed out that the drop in rig count is not changing production, they are quickly learning the lesson of trying to get a few facts to stand in the way of a good meme, but we think they are about to get listened to... while oil has stabilized, the next leg is likely lower.

Either all futures market participants are comically inept or demand is the variable that shifted hard. Those are the only two possibilities.

The recent rally in crude prices looks more like a head-fake than a sustainable turning point, suggests Citi's Ed Morse, noting that short-term market factors are more bearish, pointing to more price pressure for the next couple of months and beyond. While the shape of the oil price recovery is unlikely to be 'L'-shaped in their view (more likely 'U', 'V', or 'W'-shaped recovery), Citi warns the oil market should bottom sometime between the end of Q1 and beginning of Q2 at a significantly lower price level in the $40 range (perhaps as low as the $20 range for a while) - after which markets should start to balance, first with an end to inventory builds and later on with a period of sustained inventory draws.

Despite the collapse of several key industries (cough Steel & Construction cough), as we have discussed in detail related to the record number of VLCCs charging towards China, Chinese crude oil imports surged by almost 5 million barrels in December - the most on record. This 19.5% surge MoM (and 13.4% YoY) indicates significant efforts to fill the nation's strategic reserve but - absent this 'artificial' demand - spells problems for an already over-supplied global oil market (and its near record contango).

There's been a huge price move in oil. The spreads shows a startling picture.

The US 30-Year Treasury bond yield remains on track for new all-time lows in the weeks ahead, according to BofAML's MacNeil Curry, on the basis that crude oil prices will begin to stabilize. With the WTI curve at extreme contango, Curry suggests the downtrend is finished, and this is a very high probability location for a base to develop.

It appears that not only did Janet Yellen's soothing words from last week decouple the broad US equity market from any fears about oil prices, but energy stocks themselves now have absolutely no relationship with the underlying raw material that drives their business (and it's not like the Contango provides much support). Now where have we seen this before?

As the following snapshot from January 2009 shows, the 12 month, $25 contango back then was without precedent, and as a result there was an epic scramble by hedge funds, banks and various other speculators to store about 100 million barrels on tankers with the intention to sell later. Since the contango was so wide one could easily lease any number of VLCCs and still be profitable on the trade. In fact, a big reason for the renormalization of the crude curve back then was because so many funds jumped on this arb. Fast forward to today, because the "risk-free" contango trade is back.

Slowing the rebalancing and creating further downside risk is a very strong consensus view that this pull back is temporary and that oil prices will quickly rebound as they did in 2009. According to a recent Bloomberg survey, the median WTI forecast for 2016 is $86/bbl (even we forecast it going back to $80/bbl). All of these forecasts are based upon now outdated cost data that is shifting as fast as the price. It is precisely this strong view for a rebound in prices and the behavior it creates, that not only suggests that oil prices can go lower for longer, but also that the new normal is far lower than we thought just one month ago. Instead of optimizing against a lower price environment, many oil producers are trying to position themselves for the rebound in prices

• No Sign of Thaw in Obama’s Brief Encounters With Putin (BBG)
• Japan Lawmakers Prepare for Snap Elections as Abe Mulls Tax (BBG)
• Global stocks rise, Brent crude hits four-year low (Reuters)
• U.S., China to Drop Tariffs on Range of Tech Products (WSJ)
• ‘Too-Big-to-Fail’ Rule Would Raise Bar for Bank Capital (WSJ) ... and mean even bigger taxpayer bailouts
• Pot in New York: $100 Ticket. No Charges. No Record. No Nothing (BBG)
• Microsoft unveils first Lumia smartphone without Nokia name (Reuters)
• Davos-Man Ackermann Lured to Cyprus Bank by Billionaires (BBG)
• Alibaba, Apple Talks on Payments Tie-Up Focused on China (WSJ)

"What I’m describing here is a sea change in investor attitudes that has profound implications for the rest of the market. What you do with that information is up to you."

• To salvage his presidency, Obama faces pressure to reboot - but will he? (Reuters)
• Pro-Russian separatist Zakharchenko wins Ukraine rebel vote (Reuters)
• Russia's Recognition of Ukrainian Separatist Election Is 'Incomprehensible,' Germany Says (Moscow Times)
• Man Running World’s Biggest Wealth Fund Tackles China Riddle (BBG)
• Russian Supply Underpins Global Oil Glut (WSJ)
• Argentina accuses Procter & Gamble of tax fraud, says suspends operations (Reuters)
• ECB Skips Fireworks for Day One of New Role as Supervisor (BBG)
• HSBC Hit by $1.7 Billion of Provisions (WSJ)

It has been a relatively subdued session, with not much action in either stocks or bonds - European stocks rise for the second day on US market momentum from yesterday; Asian stocks are mixed advance while metals decline with Brent, WTI crude, U.S. equity index futures. The biggest highlight in overnight action, however, was once again the Dollar whick climbed to a fresh 4-year high, on pace to strengthen for 2 straight months for first time since March. The reason: ongoing sentiment that there will be a major dispersion between central banks, with the USD tightening just as other central banks join the liquidity fray. To wit, ECB data showed that lending decline in Europe slowed to -1.5% y/y in Aug. vs -1.6% in July and the latest statement from Draghi who said in Lithuania that economic reform possible without devaluing currency.

So much for any Scottish referendum vote "surprise": the people came, they voted, and they decided to stay in the 307-year-old union by a far wider margin, some 55% to 45%, than most polls had forecast, even as 3.6 million votes, a record 85% turnout, expressed their opinion. The gloating began shortly thereafter, first and foremost by David Cameron who said "There can be no disputes, no re-runs, we have heard the settled will of the Scottish people." Queen Elizabeth II, who is at her Scottish castle in Balmoral, is expected to make a rare comment on Friday. But while a No vote was where the smart betting money was ahead of the vote anyway, and is thus hardly a surprise, the most curious thing overnight was the complete roundtrip of cable, which was bought on the rumor and then sold off on the news, roundtripping by nearly 200 pips.

Historically market corrections and volatility spikes have been very good entry points for purchasing shares in ZIV