Oil Posts its First Weekly Gain in Eight Weeks
January ’24 WTI gained $0.20 this week to finish at $71.43/Bbl. Dovish commentary from the US Fed, followed by a weak US dollar, supported oil prices this week while the IEA and OPEC presented contrasting forecasts.
In its December monthly report, the IEA reduced its forecast for oil consumption growth in 4Q 2023 by 0.4 MMBbl/d. This slowdown is primarily attributed to weakened economic activity in Western nations and is expected to persist into 2024. As a result, the agency now projects a further deceleration in demand growth rates, estimating an increase of 1.1 MMBbl/d in 2024.
On the supply side, increased production from the US, Brazil, and Guyana is expected to counter the output cuts by OPEC+. However, OPEC's own monthly report maintained a firm oil demand forecast, projecting a growth of 2.25 MMBbl/d in 2024. The cartel attributed the recent oil price weakness to exaggerated demand concerns. Additionally, based on recent announcements from Saudi Arabia and Russia, some analysts now expect OPEC to extend its voluntary cuts beyond 1Q 2024.
Furthermore, a dovish stance by the U.S. Fed signaled by potential pausing interest rate hikes and cuts in borrowing costs, led to a weaker U.S. dollar. This, in turn, makes oil, priced in USD, less expensive for holders of other currencies, potentially supporting demand. Some analysts are penciling in three rate cuts next year, which could stimulate economic growth and may further support demand outlook.
Should OPEC+ adhere to its voluntary cuts, 1Q2024 could see a near 0.7 MMBbl/d deficit. AEGIS believes that these new output cuts could act as a floor for prices. Moreover, if Saudi Arabia and Russia decide to extend their unilateral cuts, this could introduce additional upward risk to the oil market.
Despite the general market sentiment being negative in the near-term, 2024’s supply-demand balance indicates a greater chance that prices could realize higher.
Crude Oil Factors
Geopolitical Risk Premium. (Bullish, Surprise) Considering the turmoil hitting several countries in the eastern hemisphere, we decided to add this factor. Most headlines were dominated by the escalated conflict between Hamas and Israel since October 7. The risk premium in the oil markets is most likely because of the potential supply risk from Iran. The knowledge that the Iranian government has backed Hamas and reports that Iran helped plan the weekend's attack leads many to believe there could be action taken against Iran. A harder line from Washington on Iran’s oil supply or retaliation from Israel directly on Iran are possibilities. Yet, with no Middle East production disruptions observed, the initial war premium is currently getting no credit in the price action.
Furthermore, last year's Russian invasion of Ukraine continues to weigh on prices. The EU and G7 approved the eighth set of sanctions and a price cap on Russian oil imports, which came into effect on December 5, 2023. The EU and G7 agreed upon a $60/Bbl price cap on Russian crude, which will be reviewed bi-monthly. The EU implemented a similar price cap mechanism on Russia's fuel exports on February 5.
Escalating Houthi attacks in the Red Sea are disrupting key oil trade routes, prompting major shippers like Maersk to suspend operations. Two oil tanker companies are now demanding clauses in their charters for the option to reroute around Africa, highlighting the escalating risk and need for more security in the region.
Trade Flows. (Bearish, Priced In) Traders stepping back from speculative positions on potential conflict-driven rallies has lowered volatility and is exerting downward pressure on oil prices. Oil prices tracked equity markets since March as renewed worries over the U.S. and European banking sectors subsided. AEGIS also notes that the recent movement in prices could be driven by the price trend (technical selling or buying) itself rather than the fundamentals. We see that trade flows have been affecting the price action in the commodity markets for the past few weeks, as the recent selloff in the crude market is attributed to major funds/firms liquidating.
Russian Supply. (Bullish, Priced In) Russia, the largest seaborne diesel-type fuel exporter, has halted diesel and gasoline exports from September 21 with no clear end date to control rising domestic fuel prices. Russia also extended its export curbs through December, though it tapered the curbs from 0.5 MMBbl/d in August to 0.3 MMBbl/d. Moscow has previously pledged to cut production by 0.5 MMBbl/d from March through 2024. Russia's total petroleum exports are estimated to be around 7 MMBbl/d, and the absence of even a portion of this supply, given that Russia is the world's third-largest supplier of oil, would be a significant influence in driving up prices. China and India remain to be the biggest buyers of Russian crude. The sanctions and price cap are estimated to risk 0.5 to 1.5 MMBbl/d of Russian oil production.
OPEC Market Share War. (Bearish, Surprise) The possibility exists, albeit a small one, that should OPEC's efforts to bolster oil prices through production cuts prove unsuccessful, the cartel could potentially flood the market with additional barrels as a strategy to reset.
Oil/Product Inventories. (Bullish, Priced In) Crude and refined product inventories in both the U.S. and abroad are extremely low. The EIA released its weekly oil inventory report Wednesday morning, showing a big drop in gasoline demand. In fact, it marks the lowest level in 25 years on a seasonal basis. Cushing stocks rose modestly, but this was more or less expected as refiners turned to maintenance and reduced runs. Crude data is usually on a several-month lag. IEA data shows that OECD inventories were nearly 106 MMBbl below the five-year average in October. The oil market has likely remained in a slight supply deficit since then, so inventories could be lower now, as evidenced by the backwardation in the forward curve. Additionally, volatility will likely be heightened with inventory levels at inadequate levels to serve as a "shock absorber" for prices. Distillate fuel inventories in the U.S. are 13% below the five-year average for this time of year. Meanwhile, exports continue to be high as refiners attempt to address global shortages brought on by the pandemic's quick recovery and the disruptions caused by Russia's invasion of Ukraine.
Economic Slowdown. (Bearish, Mostly Priced In) Higher interest rates are causing concern for future demand. The 10-year Treasury hit 4.8 last Wednesday, the highest level since 2007. Threats to global GDP impact oil demand growth projections. Higher global energy prices might increase the potential for an economic slowdown. Macroeconomic uncertainties could pressure oil demand and, therefore, oil prices in 2023. According to the EIA, U.S. real GDP declined by 2.8% in 2020, and they estimate U.S. GDP increased by 5.9% in 2021. They estimate GDP has risen by 2.1% in 2022 and are forecasting it would fall by 1.9% in 2023. While that doesn't sound all too bad, the main takeaway is that crude oil demand growth would likely slow with GDP, and if supply growth outpaces demand growth, then you would find yourself in a structurally weaker market. U.S. inflation was steady in September, with annual CPI at 3.7%. However, Fed officials are expected to hold rates steady while debating if another rate hike in November or December will be necessary to maintain recent progress in slowing inflation.
OPEC+ Quotas. (Bullish, Priced In) OPEC+ agreed to cut an extra 0.88 MMBbl/d in the first quarter of 2024, adding to Saudi Arabia's existing 1 MMBbl/d reduction. This aims to reduce the forecasted supply surplus of 1.3 MMBbl/d next quarter (IEA). However, skepticism among market participants due to the voluntary nature of the cut and Angola's non-compliance led to a decline in oil prices following the announcement. The UAE, Kuwait, Iraq, Kazakhstan, and Algeria, announced their respective production cuts following the meeting.
China Demand. (Bullish, Partly Priced In) China's oil demand has been severely affected in 2022 by strict COVID-19 control measures. Reduced mobility has hindered economic activity and, therefore, consumption. China eased its Covid restrictions in early December 2022 and announced a slew of economic measures to boost its economy. As the country completely emerges from the lockdowns, its oil demand is expected to rise, putting extra strain on a market that has already tightened dramatically since Russia invaded Ukraine. Chinese oil consumption is expected to hit a record high this year. According to the IEA, Chinese demand is expected to increase by 1.3 MMBbl/d in 2023. China’s demand is important as it is nearly half of the global demand growth in 2023, which the market expects to grow by about 2.4 MMBbl/d. China's Central Bank lowered the reserve requirement ratio (RRR) by 25 bps in an effort to stimulate the nation's economy.
USD/Fed (Bearish, Priced In) The Fed's recent pause in rate hikes has led to market speculation that the rate hike cycle may be nearing its end. A dovish stance by the U.S. Fed signaled by potential pausing interest rate hikes and cuts in borrowing costs, led to a weaker U.S. dollar. This, in turn, makes oil, priced in USD, less expensive for holders of other currencies, potentially supporting demand. Some analysts are penciling in three rate cuts next year, which could stimulate economic growth and may further support demand outlook.
Non-OPEC Production. (Bearish, Priced-In) Many prominent research groups (EIA, IEA, OPEC) think non-OPEC production, dominated by the U.S., will increase in 2023. If these forecasts come to fruition, it would have a slightly bearish impact on oil prices if the market were otherwise well-supplied. OPEC forecasts the 2024 non-OPEC production to increase by 1.4 MMBbl/d.
SPR. (Bullish, Surprise) The U.S. DOE announced plans to buy 6 MMBbl of sour crude for the strategic petroleum reserve delivery in December and January at $79 or less. So far this year, the government bought 9 MMBbl of oil at an average price of $75/Bbl and secured nearly 4 MMBbl in accelerated exchange returns. DOE also solicited 3 MMBbl for March 2024. In response to the Russia-Ukraine war and rising gasoline prices, the Biden administration drew the SPR by 180 MMBbl to a 40-year low of 351 MMBbl from its 714 MMBbl capacity. Additionally, the DOE confirmed a prior purchase of 4.8 MMBbl at an average price under $73/Bbl and said it will continue monthly solicitations for available capacity through May 2024.
OPEC Reversal/Compliance. (Bearish, Surprise) The new voluntary OPEC+ production cuts put member nations' adherence to quotas under scrutiny. Any deviation, such as halting, reversing, or exceeding their quotas, could end up being one of the surprise bearish factors weighing on the market.
China Inventories. (Bearish, Mostly Surprise) China has an inventory capacity of 1 -1.2 Billion barrels, and inventories are currently around 960 MMBbl as of November, according to Vortexa. Over the first eight months of the year, China accumulated about 130 MMBbl in its oil inventories, giving it considerable flexibility in its import decisions. Since August, China has been destocking and so far has withdrawn about 70 MMBbl. If China's refiners, influenced by high global prices, opt to reduce imports and tap into these stockpiles more, it could exert downward pressure on global crude prices. Historically, China has reduced imports when crude prices surge. Yet, the market appears to be underestimating this potential impact on crude demand.
"Fragile Five" Production. (Bearish, Surprise) The Citi Bank coined the term that includes Iran, Iraq, Libya, Venezuela, and Nigeria - which have historically faced turbulence in their crude oil production. However, despite past disruptions, they are projected to boost production by approximately 0.9 MMBbl/d barrels this year, and a similar increase is expected next year. This surprising growth in output could pose a bearish risk to global crude prices, especially as oil demand may be tempered by slowing expansion in China.
Furthermore, the Iran nuclear deal negotiations concluded on August 8 after 16 months. U.S. Secretary of State Antony Blinken said that an agreement in the near future is unlikely. However, Iran's production and exports have surged to over 3.4 MMBbl/d and nearly 1.5 MMBbl/d, respectively, due to quiet diplomacy with the U.S. after Iran released five Americans in September. If an agreement is reached, the nation may increase output by nearly 1 MMBbl/d, perhaps starting in phases. The possibility of ending or reducing Iran sanctions poses a downside risk to oil prices.
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