WTI Falls More Than $2 Amid Dollar Strength and Oversupply Concerns
The December NYMEX WTI contract settled lower by $2.89/Bbl to $67.49/Bbl. Prompt prices are now trading near the bottom end of the range that WTI has been trading in since early September. The US dollar index has risen to its highest level in over a year, pressuring crude prices lower, meanwhile concerns of oversupply have led to increased bearish sentiment in oil markets.
The US dollar index has posted significant gains over the past two months, which have been further extended following last week’s US presidential election. Now up more than 6% since the start of October, a strong dollar has likely helped keep crude prices lower, as there is typically an inverse relationship between the two.
In addition, concerns of oversupply in global crude markets have been mounting. This week multiple forecasters lowered their demand expectations for 2024 and 2025, increasing the bearish sentiment around next year. The International Energy Agency warned of a potential 1 MMBbl/d gap between supply and demand next year, while OPEC also cut their forecasts for oil demand. These expectations are mostly driven by weak Chinese consumption and higher supply from both OPEC and non-OPEC producers. Despite OPEC lowering its forecast, the group still remains relatively bullish on the supply-demand picture compared to other forecasters such as the IEA.
Meanwhile, Citigroup said in a note that a second Trump presidency could lead to a net-bearish outlook for crude prices, driven by tariffs and more favorable policies for domestic US oil production.
AEGIS maintains a neutral outlook for 2025 based on projected oversupply and weak demand growth. Potential Middle East disruptions are not included in this base case.
Crude Oil Factors
Geopolitical Risk Premium. (Bullish, Surprise) As there has been no disruption to any supplies so far, prices have shaken off the attacks on ships in the Red Sea. However, headline risks can potentially shock prices higher in the near term. Considering the turmoil hitting several countries in the eastern hemisphere, we decided to add this factor. Since October 7, 2023, 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.
Middle East risk premium is added back into oil prices after Iran attacked Israel on October 1 with over 180 ballistic missiles. Oil prices rallied over $6 for the week ending October 4 after President Biden said the US was discussing whether to support potential attacks on Iranian energy infrastructure. Israel has said it will not attack Iran's oil or nuclear facilities. The risk premium in oil prices faded after Israel's limited response, as urged by the U.S. Prices fell below $70 on October 18 as the US was pushing for a ceasefire deal with Gaza.
However, prompt month WTI jumped above $70 in late trading after Axios reported that Iran is preparing a major retaliatory strike on Israel out of Iraq.
Some geopolitical risk premium is priced back into oil prices whenever there are material Ukrainian drone attacks on Russian refineries; this happened numerous times this year. The June 20 attacks knocked out nearly 5% of Russia's refining capacity, according to Bloomberg estimates.
Trade Flows. (Mostly Bullish, Priced In) Traders are stepping back out of speculative positions amid potential weakness in demand, forecast for an oversupply in 2025, and broader equities sell-off is exerting downward 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 price action in commodity markets in recent months, as recent movements in the crude market have partially been attributed to algorithmic selling.
Money managers have increased net bullish WTI bets to the highest in four weeks. This reflects increased bearish sentiment due to OPEC⁺'s plan to unwind production cuts and a weak global economic outlook. Manufacturing momentum has stalled, and concerns about economic deceleration have pushed oil prices to their lowest level this year. However, if the slowdown doesn't materialize and inventory depletion continues, prices could rebound, driven by fund managers rebuilding positions.
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. OPEC has pushed its plan to unwind existing 2.2 MMBbl/d production cuts by two months. Now, starting in December, the unwind is set to gradually bring 180 MBbl/d of oil back into the market every month.
Oil/Product Inventories. (Bullish, Mostly Priced In) Crude inventories in the US sit at the lowest level since January while stocks at Cushing are at their lowest since November. 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 October IEA report, OECD inventories were nearly 100 MMBbl below the five-year average as of August. 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. Distillate fuel inventories in the U.S. are 9% 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 latest U.S. economic data revealed a stronger-than-expected GDP growth of 2.9% annualized in 2Q. Meanwhile, the PCE price index, the Fed's preferred inflation measure, rose 2.1% Y-o-Y in September,the smallest year-on-year rise since February 2021 and followed a 2.3% advance in August. In September, the CPI rose by 2.4% Y-o-Y, indicating that inflation is falling in line with the Fed’s 2% target. Swap traders now forecast a 43 bp rate cut for the rest of the year. Macroeconomic uncertainties could pressure oil demand. 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 2.4% 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.
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. OPEC+ members agreed on September 5 to delay a planned gradual 2.2 MMBbl/d supply hike by two months, shifting the start to December. The group will add 0.19 MMBbl/d in December and 0.21 MMBbl/d from January onwards, with an option to adjust or pause these hikes depending on market conditions. The cartel also reaffirmed its compensation cuts of 0.2 MMBbl/d per month through November 2025, as members such as Iraq, Russia, and Kazakhstan have struggled to meet their original production quotas.
AEGIS notes that the global crude market would quickly build inventories without OPEC's support in reducing supply.
OPEC Unwind/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. OPEC has delayed the unwind of its 2.2 MMBbl/d voluntary production cut for a second time to January despite its forecast of nearly 2 MMBbl/d demand growth in 2025. This cautious approach reflects weak demand, particularly from China, and rising non-OPEC supply, which keeps downward pressure on prices. Typically, OPEC+’s output cuts act as a price floor, but with up to 6 MMBbl/d in spare capacity, the group can act as a cap for prices as well, likely to adopt a month-to-month strategy that could test group cohesion over time.
China Demand. (Bearish, 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. Absolute 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 just 0.18 MMBbl/d in 2024. China underpins the deceleration in growth, accounting for around 20% of global gains both this year and next year, compared to almost 70% in 2023. China’s demand is important as it is nearly half of the global demand growth in 2024. However, China's apparent oil demand fell 6.98% Y-o-Y in September to 14.18 MMBbl/d, driven by weakness in fuel demand.
USD/Fed (Bullish, Surprise) The US dollar index had a sixth consecutive weekly gain, climbing above the 200-day SMA, supported by a 25 bps Fed rate cut and renewed investor confidence tied to potential Trump policies. Trump’s proposed tariffs on China and Europe are expected to stoke inflation, while Republican-led tax cuts might offset growth impacts, though potentially widening the budget deficit. Fed Chair Jerome Powell indicated that while inflation remains a concern, further rate cuts could slow if inflation rises, with future moves contingent on labor market shifts. Economic resilience and US outperformance versus G10 peers underpin the Dollar's robust 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. IEA forecasts the 2024 and 2025 non-OPEC production to increase by 1.5 MMBbl/d.
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