Oil Holds at November Highs as IEA Flips its Forecast to Deficit on OPEC+ Cuts
April ’24 WTI gained $3.03, or 4%, this week to finish at $81.04/Bbl. Oil prices rallied this week to a four-month high following Ukrainian attacks on Russian refineries and the IEA forecasting a sizable undersupply for 2024, taking into account future OPEC+ cuts for the first time.
The March IEA monthly report marks a significant shift in expectations for the global oil market in 2024. The agency projects a deficit of 0.32 MMBbl/d, starkly contrasting its previous forecast of a 0.8 MMBbl/d oversupply and consequent inventory builds.
This adjustment stems from the first-time inclusion of expected OPEC+ production cuts extending through the year's end, a view that diverges from OPEC's announcement of cuts lasting until 2Q 2024. This outlook adjustment, which AEGIS has incorporated into its OECD inventory analysis for some time now, reinforces the basis for a bullish oil market outlook into 2024.
Within the same report, the agency raised its global demand growth forecast by 0.11 MMBbl/d to 1.3 MMBbl/d, citing a robust US outlook and increased ship fuel demand. However, this is still below OPEC's 2.2 MMBbl/d and Vitol's 1.6-1.8 MMBbl/d projections on the backs of petchem usage in China and diesel demand in India.
On the geopolitical front, Ukrainian drones attacked three Russian refineries over the past week, knocking out nearly 12% of Russia's oil processing capacity, elevating geopolitical risks, and countering the typical downward pressure on oil prices from increased crude awaiting processing.
Furthermore, in preparation for summer, US refiners are ramping up production of summer-grade gasoline amid their biggest refinery turnaround since 2019. Capacity reductions peaked at the end of February with 0.95 MMBbl/d offline and are expected to decline to 0.20 MMBbl/d by the end of March (RBN). This shift has increased refinery utilization from 80.6% in mid-February to 86.8%, led to the first drop in crude inventories since January, and supported the 3-2-1 crack spread (refining margin) to a six-month high of $32.40 on Wednesday.
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 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.
Cease-fire prospects in the Israel-Hamas conflict dimmed as Israel geared up for operations in southern Gaza amidst escalating tensions in the region. Netanyahu's insistence on "total victory" over a ceasefire, combined with Iraq's threat to withdraw support from the U.S.-led coalition, further complicated matters. Concurrently, the
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.
Trade Flows. (Bullish, Priced In) Traders stepping back from speculative positions on potential conflict-driven rallies has increased volatility and is exerting upward pressure on oil prices. Oil prices tracked equity markets since March 2023 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 rally in the crude market is attributed to algorithmic buying.
Russian Supply. (Bullish, Priced In) Russia has halted gasoline exports from March through November to control rising domestic fuel prices. Also, 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.
Since the beginning of 2024, Ukrainian drone attacks have significantly affected Russian oil refineries. The attacks reduced Russian oil refinery output by 12% so far in March. These incidents are part of a series of strikes targeting Russian energy infrastructure, including attacks on oil depots and refineries in various regions, contributing to disruptions in Russia's ability to export oil products. Additionally, Russia has adhered to its pledge and curbed exports by 0.49 MMBbl/d in January.
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 low. Crude data is usually on a several-month lag. IEA data shows that OECD inventories were nearly 100.5 MMBbl below the five-year average in January. 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 have caused concern for demand throughout 2023. The 10-year Treasury hit 4.8 in October, 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 rise by 2.4% 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. Some analysts expect the Federal Reserve to cut interest rates in 2H 2024. Lower interest rates cut consumer borrowing costs, which can boost economic growth and oil demand.
OPEC+ Quotas. (Bullish, Priced In) On March 3, OPEC+ extended their 2.2 MMBbl/d production cuts through June, aligning with market expectations amidst increasing non-OPEC supply and uncertain global demand. Saudi Arabia is extending its voluntary 1 MMBbl/d cut, keeping output at 9 MMBbl/d. Additionally, Russia's cut of 0.47 MMBbl/d in Q2 could tighten the Urals supply.
AEGIS notes that the global crude market would quickly build inventories without OPEC's support in reducing supply. Furthermore, IEA now projects a deficit of 0.32 MMBbl/d, a stark contrast to its previous forecast of a 0.8 MMBbl/d oversupply and consequent inventory builds. This adjustment stems from the first-time inclusion of expected OPEC+ production cuts extending through the year's end, a view that diverges from OPEC's own announcement of cuts lasting until 2Q 2024.
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 emerged from the lockdowns, its oil demand was expected to rise, putting extra strain on a market that has already tightened dramatically since Russia invaded Ukraine. However, the pace of Chinese demand growth has been slow compared to what the market had expected. Chinese oil consumption is expected to hit a record high this year. According to the IEA, Chinese demand rose by 1.7 MMBbl/d in 2023 and is expected to increase by 0.7 MMBbl/d in 2024. China’s demand is important as it is nearly half of the global demand growth in 2024, which the market expects to grow by about 1.2 MMBbl/d.
USD/Fed (Bearish, Priced In) US Federal Reserve Chair Jerome Powell suggested the central bank is getting close to the confidence it needs to start lowering interest rates. “We’re waiting to become more confident that inflation is moving sustainably at 2%,” Powell said Thursday in an appearance before the Senate Banking Committee. “When we do get that confidence—and we’re not far from it—it’ll be appropriate to begin to dial back the level of restriction.” Fed's signal of starting to cut rates led to a weaker U.S. dollar, the lowest since mid-January. This, in turn, makes oil, priced in USD, less expensive for holders of other currencies, likely supporting demand.
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. IEA forecasts the 2024 non-OPEC production to increase by 1.6 MMBbl/d.
SPR. (Bullish, Surprise) The U.S. DOE has bought back nearly 23 MMBbl of crude so far and solicited 3 MMBbl for June 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.
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 900 MMBbl as of January, according to Vortexa. Over the first eight months of 2023, China accumulated about 130 MMBbl in its oil inventories, giving it considerable flexibility in its import decisions. Since August, China has been destocking, withdrawing approximately 100 million barrels. If prices remain range-bound or relatively low, China might start restocking, preparing for times when refiners, responding to high global prices, opt to reduce imports and draw more from these stockpiles. This could exert downward pressure on global crude prices. Historically, China has reduced imports when crude prices surge; however, the market seems 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.
China-Taiwan Conflict. (Bearish, Surprise) Should the China-Taiwan conflict escalate, it may lead to increased sanctions on China, the world's largest oil consumer, and pose a significant bearish risk to oil prices. These sanctions could substantially weigh on China's oil demand. Beyond the oil market, such sanctions would have broader repercussions, disrupting international trade, undermining global economic stability, and straining geopolitical relations. The impacts would be felt across global supply chains and in countries reliant on economic ties with China.
Ceasefire(s). (Bearish, Surprise) The crude oil market is currently seeing prices rally partly due to the geopolitical risk premiums associated with three major conflicts: the Russia-Ukraine war, the ongoing Israel-Hamas hostilities, and the Houthi attacks on Red Sea shipping. These conflicts have significantly contributed to the uncertainty in the oil markets, pushing prices upward as market participants weigh the risks of supply disruptions and increased tensions.
However, there's an inherent risk that a ceasefire or de-escalation in any of these situations could lead to a sudden decrease in oil prices. This potential for headline risk could see prices adjust quickly if, for instance, Ukraine and Russia move towards peace, the Houthis halt their maritime assaults, or a ceasefire is brokered between Israel and Hamas, reducing the current geopolitical risk premium embedded in the price of oil.
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