Crude prices move higher for a third week, reaching an eight-week high.
WTI prices gained 76c this week to settle at $81.49/Bbl, which marks the highest weekly settlement since late April. The 2025 Calendar strip posted a 61c gain to finish the week at $74.58/Bbl. The August contract has gained $3.44 over the past two weeks and is up nearly $9 from the lowest point in June. Prices have continued to increase since the selloff following the last OPEC meeting, partially driven by higher geopolitical risk premium despite signs of weakness in physical markets.
After a quiet period, tensions in the Middle East have increased, leading to higher geopolitical risk premium in crude prices. Earlier this year, attacks by Houthi militants in the Red Sea led to higher crude prices and a rerouting of flows away from the key waterway. Attacks decreased for some time following the creation of a multinational naval coalition, but they have ramped up again. Several ships have been hit with missiles over the past few weeks, marking a resurgence of violence in the area and leading to more ships taking longer but safer routes. In other news, Israel has moved military assets away from Gaza and toward the southern border of Lebanon, potentially preempting an invasion or military action against Hezbollah, which is based in southern Lebanon. Tensions in the region have led to concerns about a wider regional conflict that could disrupt crude flows.
Demand from refineries in Asia remains weak, with refinery margins falling and forcing some processors to cut throughput. In addition, large volumes of oil are waiting on the water for buyers to materialize, with 25 MMBbls of Nigerian crude currently idling in the Atlantic Basin. Citi warned this week that due to these signs of weak demand, recent gains in crude could be “fragile.”
AEGIS remains bullish on the curve, expecting prices in further out tenors to roll up towards prompt prices. While OPEC’s plan to gradually bring back supply might prevent the most bullish scenarios, the cartel reiterated its support for prices and maintaining market balance, avoiding an oversupplied oil market.
Crude Oil Factors
Geopolitical Risk Premium. (Bullish, Surprise) As there has been no disruption to any supplies so far, prices have shaken off the recent attacks on ships in the Red Sea and also the escalating Israel-Hamas conflict. However, headline risks have the potential to support prices in the near-term. Considering the turmoil hitting several countries in the eastern hemisphere, we decided to add this factor. Since October 7, most headlines have been dominated by the escalated conflict between Hamas and Israel. The knowledge that the Iranian government has backed Hamas leads many to believe action could be taken against Iran.
Some geopolitical risk premium has been priced back into oil prices following Ukrainian drone attacks on four Russian refineries on June 20. These refineries account for nearly 5% of Russia's refining capacity, according to Bloomberg estimates. Furthermore, renewed confrontations between Israel and Hezbollah on the Israel-Lebanon border, along with the Houthi's sinking of a bulk carrier in the Red Sea, are escalating geopolitical risks.
Israel said the terms of a ceasefire proposal Hamas accepted on May 6 remained “far from” meeting its demands and warned its military operations in Rafah would continue, even as it sent negotiators to talk to mediators.
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. (Bearish, Priced In) Traders stepping back into speculative positions on renewed conflict-driven rallies and upcoming summer demand 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 movements in the crude market are partially attributed to algorithmic buying. Renewed geopolitical tensions have prompted money managers to increase their bullish oil bets, positioning Brent and WTI at their most bullish in three weeks.
Russian Supply. (Bullish, Priced In) Russia has halted gasoline exports from March through November 2023 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 14% in May. 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. Furthermore, Ukraine conducted a swarm of drone attacks on four Russian refineries on June 20. 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, Mostly Priced In) Crude inventories in the US have risen to their highest since June. Meanwhile, refined product inventories in both the U.S. and abroad are low. Crude data is usually on a several-month lag. According to the April IEA report, OECD inventories were nearly 65 MMBbl below the five-year average as of February. 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 7% 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) The U.S. GDP growth rate of just 1.6% in Q1 2024, significantly below the anticipated 2.4%, has heightened concerns about an economic slowdown, negatively impacting both equity and oil markets. Higher interest rates have caused concern for demand throughout 2023. 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. 2.5% in 2023 and are forecasting it would rise by 2.6% in 2024. 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 June 2, OPEC+ announced its extension of 3.66 MMBbl/d cuts through December 2025. Additionally, the 2.2 MMBbl/d voluntary cuts from eight member countries will continue into Q3 2024 but will start to be reversed in October at a rate of 0.18 MMBbl/d per month. However, OPEC+ indicated that these monthly production increases could be "paused or reversed subject to market conditions." Furthermore, the Saudi Energy Minister led ministers this week in reiterating that the production increase can be paused or reversed based on market conditions.
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 0.43 MMBbl/d,starkly contrastingo 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. Manufacturing activity in March expanded for the first time in six months, according to an official factory survey.
USD/Fed (Bearish, Priced In) Last
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.
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-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 price action 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/downward 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.
In mid-April, when WTI was trading around $88/Bbl, a geopolitical risk premium of $5-10/Bbl was estimated to be priced in due to the Middle East tensions. This premium appears to have eased recently following Israel's limited retaliation against Iran.
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