Oil Posts a Third Consecutive Weekly Loss as Demand Uncertainty Lingers
Oil prices saw a significant decline this week but managed to rebound slightly on Friday, snapping a four-day losing streak. The June ’23 WTI contract lost $5.44 or 7% on the week to finish at $71.34/Bbl. Concerns about the economic outlook and its effect on demand have subdued the rally that started earlier this month after OPEC+'s surprise production cuts.
U.S. job openings dropped for the third consecutive month in March, and layoffs reached their highest level in over two years. However, better-than-expected U.S. payroll data on Friday helped ease some concerns about the looming economic downturn. The Federal Reserve raised interest rates by 25 basis points as anticipated and hinted at a potential pause in rate hikes.
Meanwhile, China's manufacturing PMI fell short of estimates, but seaborne crude oil shipments to the country reached a two-year high last month. Furthermore, air travel during China's Labor Day holiday exceeded pre-pandemic levels, offering a glimmer of hope for the oil market amidst broader demand concerns.
Uncertainty over Russia's commitment to a 0.5 MMBbl/d production cut till year-end has also weighed on crude prices. However, Russian Deputy PM Novak confirmed compliance, stating that increased tanker exports don't notably offset reduced pipeline shipments.
On balance, AEGIS believes that price risk is skewed to the upside in 2023 due to supply shortfalls and upside demand risks. AEGIS acknowledges that global economic concerns are real but is staying with a bullish outlook. Furthermore, low OPEC spare capacity could lead to slight scarcity and more leverage on price than usual. This vulnerability makes the market susceptible to upsets in the daily flow of oil supply.
AEGIS hedging recommendations for crude oil remain costless collars for 2023 and 2024. A collar would set a price floor but allow for more upside participation, compared to a swap if prices realize higher. The upside exposure afforded by the structure makes it very popular among our clients with a bullish bias.
To see details on factors we believe are affecting oil prices and trade recommendations, click the "Read More" button on the Factor Matrix section in the AEGIS Research Module.
Crude Oil Factors
Geopolitical Risk Premium. (Bullish, Surprise) We decided to add this new factor, considering the recent turmoil hitting several countries in the eastern hemisphere. Most headlines are dominated by the Russian invasion of Ukraine, which has been the driving factor behind the prices. The European Union and G7 approved the eighth set of sanctions and a price cap on Russian oil imports, which came into effect on December 5. 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 tensions in the eastern hemisphere, including the alliance of Saudi Arabia and Iran mediated by China, along with reports of potential Saudi-Syria ties, which could further impact the region's stability, might also act as a risk premium on oil prices.
Trade Flows. (Neutral, Priced In) June '23 WTI lost $5.44 to settle at $71.34/Bbl this week. Prices fell this week amid renewed concerns of economic slowdown stoking demand fears. Oil prices tracked equity markets lower last month as renewed worries over the U.S. and European banking sectors revived fears of a credit squeeze and an economic downturn. AEGIS also notes that the recent movement in prices could be driven by the price trend (technical selling) 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.
Iran. (Bearish, Surprise) 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." If an agreement is reached, the nation may increase output by nearly 1 MMBbl/d, perhaps starting in phases beginning in 2023. The possibility of ending or reducing Iran sanctions poses a downside risk to oil prices. This is one of the bearish non-economic factors that could pressure oil prices in 2023.
U.S. - China Tensions. (Bearish, Surprise) The tensions between the U.S. and China have been fueled by a range of issues, including trade imbalances, technology competition, human rights concerns, military tensions, and ideological differences. Both countries have accused each other of unfair practices while expressing concern about the other's actions. The latest trade tensions stem from the U.S.’s effort to clamp down on China’s access to critical semiconductor technology and to impose export restrictions.
According to a Goldman Sachs survey at their Global Macro Conference, ‘U.S. – China tensions’ was the most concerning factor to many investors this year. Escalated tensions between the U.S. and China could potentially reduce demand due to trade barriers and slower economic growth.
Russian Supply. (Bullish, Surprise) The Russian invasion of Ukraine has not yet resulted in a major shortage of oil on the market. Doubts about Russia's commitment to maintaining a 0.5 MMBbl/d output cut until the end of the year have weighed on crude prices. Nonetheless, Russian Deputy PM Novak verified adherence, asserting that the rise in tanker exports does not significantly counterbalance the decrease in pipeline deliveries. 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. Additionally, the ban on Russian fuel exports came into effect on February 5. However, there is little corroborating data yet to show Russian supply loss.
Oil/Product Inventories. (Bullish, Priced In) Crude and refined product inventories in both the U.S. and abroad are extremely low. Crude data is usually on a several-month lag. IEA data shows that OECD inventories were 7.5 MMBbl below the five-year average in 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 14% 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.
Supply Chain. (Bullish, Priced In) U.S. producers are struggling with supply chain disruptions, such as a shortage of workers and equipment, a scarcity of sand for fracking operations, and high metals prices, to take advantage of increased global demand and high oil prices. These constraints could influence driving the prices up.
Economic Slowdown. (Bearish, Mostly Priced In) Fears persist about the potential broader economic impact following the failure of Silicon Valley Bank (SVB) and Signature Bank, as well as the share crash and rescue bid for giant Credit Suisse and the pressure on other regional banks in the U.S., indicating that banking fears have not completely dissipated despite rising optimism.
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 1.1% 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. CPI, an indicator of household goods inflation, showed the annual inflation rate fell for the ninth consecutive month to 5.0% from February's 6.0%.
OPEC+ Quotas. (Bullish, Slightly Priced-In) OPEC+ surprised the market with a voluntary cut of 1.66 MMBbl/d from May to the end of 2023, aiming to stabilize the oil market. Saudi Arabia and Russia will take the lead with reductions of 0.5 MMBbl/d each, followed by other member nations. The latest announcement brings the total volume of cuts by OPEC+ to 3.66 MMBbl/d, equal to about 3.7% of global demand. The market may not be pricing in the OPEC-driven supply deficit yet, as the output cuts are not expected to have a significant impact until after May. Many OPEC+ members, including Russia, are already vastly underproducing compared to their quotas. This policy of quotas, which had been in place since mid-2021, has been revised in light of a decline in Russian output due to additional sanctions. Many analysts question how much spare capacity the group really has left. Several countries, such as Angola and Nigeria, have underperformed relative to their quotas. These shortfalls have exacerbated recent market tightness.
China Growth. (Bullish, Surprise) 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. When 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 will increase by 0.9 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 anywhere from 1.7 to 2.1 MMBbl/d. China's manufacturing PMI missed expectations in April, yet the nation's seaborne crude oil imports hit a two-year peak last month. Additionally, air travel during China's Labor Day holiday surpassed pre-pandemic levels, providing a ray of optimism for the oil market in the face of wider demand worries.
USD/Fed (Bearish, Priced In) The U.S. dollar has weakened relative to its recent highs. The movement in DXY was one of the bullish factors affecting crude prices this week. A weak dollar can cause foreign buyers of dollar-denominated commodities to pay less for the same amount of goods. Fed Chair Jerome Powell hinted at a potential pause in rate hikes following last week's 25 basis-point interest rate hike.
Non-OPEC Production. (Bearish, Surprise) 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. EIA forecasts the 2023 non-OPEC production to increase by 0.5 MMBbl/d.
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