By Ryan Fitzmaurice, senior commodity strategist at Rabobank
Mixed Message In The Oil Market Outlook
Oil prices were volatile this week on headline-driven trade but still managed to grind higher
The latest CPI print came in above expectations again, reinforcing already widespread inflation fears and adding more fuel to the commodity rally
RIN prices have been surging this year, but a headline suggesting the Biden administration is considering options to help refiners sent ethanol RINs and the gasoline crack tumbling Friday
Crude oil prices were firm for the most part this week except for a brief period on Thursday when a misleading headline suggested that the US had removed all oil sanctions on Iran. The headline turned out to be false though and it was only one individual with ties to the Iranian oil industry who the US state department removed sanctions on. As such, the oil price snapped back after falling sharply on the initial reports and even managed to close at multi-year highs on the day.
Nonetheless, the full removal of oil sanctions is likely forthcoming if the nuclear talks are to move forward, something that the Biden administration appears hell-bent on, so it should come as no surprise to the oil market when that day does come. Importantly, and as we have noted in the past, many ship trackers have been indicating that Iran has already been increasing crude production and oil shipments to China via covert methods for months now, so the removal of oil sanctions is likely to be less impactful to physical crude balances, but financial headline risk is still ever-present as we saw this week.
Prior to Thursday’s false Iran headline was perhaps a more important and genuine headline regarding a spike in the US consumer price index or CPI. The year-on-year CPI print came in strong at +5%, beating market expectations of +4.7% and taking CPI to the highest levels in more than a decade. The month-on-month figure was up +0.60% which suggests there is more than just base effects at play. This data is important as it is likely to reinforce already widespread inflation fears and add more fuel to the commodity rally as investors continue to pour into the alternative asset class. On that note, it was another strong week for commodity index ETFs with roughly +300mm USD of inflows reported. On the other hand, aggregate open interest data for oil futures has been falling in recent days as prices have rallied, suggesting that some lingering oil "shorts" are throwing in the towel and covering positions.
Renewable credits (RINs)
As we just explained, oil prices were quite volatile on Thursday as a result of headline-driven trade and that theme continued into Friday with refined products dropping sharply early in the session. The refined product weakness came on the back of a headline suggesting that the Biden administration is considering options to help small US refiners who are struggling with surging renewable credits or RIN prices, as they are better known.
For those unaware, the federal government mandates that a certain percentage of bio-fuels are blended into traditional fuels under the Renewable Fuel Standard Program (RFS). The RFS was created in 2005 as a way to reduce greenhouse gas emissions and to promote the expanded usage of renewable fuels while simultaneously reducing the US dependency on petroleum-based products.
The RIN prices are broken out into four distinct categories: Ethanol D6, Biomass-based Diesel D4, Advanced Biofuel D5, and Cellulosic Biofuel D3. As can be seen in Figure 3, all four categories have rallied sharply this year as demand for finished fuels recovers strongly while supply of renewables remains tight.
As it stands, ethanol is the most commonly traded RIN as that is the most developed category with a now long-standing relationship as a gasoline blend stock component. In fact, roughly 10% of the US gasoline pool is made up of corn-based ethanol which can be a challenge for small US refiners to source unlike their much larger and integrated competitors.
Part of the difficulty with ethanol is the fact that it is corrosive and therefore needs to be railed rather than moved on a pipeline, so the actual blending takes place at the gasoline “rack” and not the refinery. This presents a challenge for small refineries that do not have the capability to produce ethanol or the logistical assets to source it.
As such, these refiners are forced to purchase RINs to meet their obligations which is particularly burdensome in the current high price environment. In fact, under the Trump administration, smaller refineries were granted exemptions from the federal mandate and that action resulted in much weaker RIN prices. The gasoline crack spread tends to be highly correlated with RIN pricing, so the sharp move lower in RBOB Friday was a response to the potential for weakness in RIN prices to develop should exemptions be granted again under the current administration.
We view this scenario as highly unlikely though as exemptions would only work to undermine the administration's green agenda, so it wouldn’t surprise us to see a reversal in gasoline prices as the headline is clarified, similar to what we saw in crude oil markets Thursday.
Looking forward, we continue to expect strong inflows into commodity index products on the back of the most recent CPI print and as part of a strategic investor rotation back into commodity markets. This buying pressure is likely to keep oil prices trending higher, providing a good backdrop to buy headline-driven drops in oil prices, as we saw this week. In terms of RIN prices, we see the prospect of higher prices as the Biden administration pushes forward its green agenda.