Head of Commodity Strategy
Summary: Crude oil prices rose on Tuesday after Saudi Arabia and Russia announced an extension to current production and export cuts to yearend. We see the extension being driven by Saudi Arabia’s desire to keep stable to higher prices into a period where macroeconomic concerns continue to weigh and demand for crude oil slows as maintenance cut refinery demand. In Brent, the medium-term uptrend is still firm with trendline support currently at $84.25, potentially being the bottom of a new higher range supported by OPEC’s active management of supply
Global Market Quick Take: Europe
Crude oil prices rose on Tuesday after Saudi Arabia and Russia announced an extension to current production and export cuts to yearend. Brent crude oil traded above $90 for the first time since November while WTI, which in recent weeks have led the rally amid falling domestic crude stocks, touched $88 before running out of steam, partly due to the fact an extension was expected and was already partly priced in.
We see the extension being driven by Saudi Arabia’s desire to keep stable to higher prices into a period where macroeconomic concerns continue to weigh and demand for crude oil slows as maintenance cut refinery demand. Not least in Saudi Arabia where refinery maintenance from October will cut capacity by 0.73 million barrels per day (Source: Energy Aspect) thereby leaving more crude oil available for exports into a period where overall demand is likely to slow past the peak summer travel season.
OPEC’s production stood at 27.8 million barrels per day last month (Source: Bloomberg), a year-on-year decline of 1.8 million barrels per day and lowest since October 2021 when global demand was still in post-pandemic recovery phase. During the same period, the estimated production capacity has held steady at around 34 million barrels per day, thereby lifting the available spare capacity above 6 million barrels per day. Rising spare capacity and rising crude oil prices rarely go hand in hand that well, and it highlights the fact that the current tightness is driven by political decisions, not because the world is running out of oil.
China’s demand for crude oil is currently strong, driven by stock building and demand from refineries, some of which is reexported as fuel products. Rising oil prices into a slowing economy, not only in China, but also in Europe and later this year, potentially also the US does not in our opinion support sharply higher prices. A risk reflected in the positions held by managed money accounts, such as hedge funds and CTAs.
In addition, higher oil prices may trigger a production response from producers both in and outside of OPEC, the latter from the three producers (Iran, Libya and Venezuela) not bound by quotas and who have raised production by 0.8 million barrels per day during the past year.
Since the current uptrend began back in early July - when the unilateral production cut was announced by Saudi Arabia, WTI has rallied by 22% and Brent by 18.5%. During this time, however, the managed money position in WTI and Brent has only risen by 158.5k contracts or 158.5 million barrels to 390k contracts, well below the February peak at 491k contracts. Breaking down the increase we find the change has primarily been driven by 102.6k contracts of short covering while the gross long has only increased by 55.9k.
Do note that this group tends to anticipate, accelerate, and amplify price changes that have been set in motion by fundamentals. Being followers of momentum, this strategy often sees this group of traders buy into strength and sell into weakness. The fact that the strong momentum since July has not triggered a bigger appetite for crude oil exposure highlights the politically driven nature of the current tightness and the weakening macroeconomic backdrop.
For now, tight market conditions are still on clear display through the elevated backwardation shown across the forward price curve, not least at the very front where prompt spreads in WTI and Brent both commanding a backwardation around 65 cents per barrel, up from close to flat around the time Saudi production cuts were implemented. While the upside in our opinion remains limited there is no doubt that the current production cuts will keep the oil market tight, thereby providing support for oil prices, but whether that support translate to stable or higher prices will depend on incoming macro-economic data, and with that the outlook for demand.
From a technical perspective, Brent has been in a bullish uptrend since July and needs to hold support at $89 as a break may trigger long liquidation towards $87.5 from traders who bought the production cut extension news. In addition, the RSI is showing divergence ie the uptrend is stretched short-term. However, the medium-term uptrend is still firm with trendline support currently at $84.25, potentially being the bottom of a new higher range supported by OPEC’s active management of supply. We do not join the $100 per barrel camp but will not rule out a relative short period where Brent could trade above $90.
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As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
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