Head of Commodity Strategy
Summary: Crude oil trades softer despite Sunday's OPEC+ meeting where Saudi Arabia announced they would make a unilateral cut of one million barrels per day, so far only in July. A decision that on paper should be mildly positive but the subsequent price action highlights the current focus on demand worries, and while the cut may support a floor under the market, the upside potential remains limited. Once the technical and/or fundamental outlook eventually turn more price friendly OPEC should 'watch out' for emerging support from a group that currently hold the weakest energy long in more than ten years.
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The long-awaited OPEC+ meeting last weekend did once again provide the market with a lot of information and changes to digest. The sum of that information, not least Saudi Arabia’s decision to make a unilateral cut of one million barrels per day, so far only in July, should be considered mildly bullish as it would help to tighten the market. However, the market chose to see it differently, basically concluding that OPEC doubts its own projections of a +2 million barrels per day increased in 2023 demand, most of which has been expected to materialize during the second half of the year.
The overall sentiment among analysts has in recent month been heavily leaning to a tightening crude oil market during H2 with OPEC’s own data indicating that global oil demand will exceed supplies by an average of roughly 1.5 million barrels a day in the second half of the year
It leaves us to conclude that for now the main driver of crude oil prices continues to be concerns about the global growth and demand outlook, not only in China, the world’s biggest importer, but also the US and other key consuming regions. Following last week’s short-covering rally ahead of the meeting, sellers have re-emerged, not least from macroeconomic-focused funds seeking a hedge against such a slowdown. In addition, the market may also worry what happens next if market conditions in the coming months prevent Saudi Arabia from adding the barrels back in, either through rising production from others or an economic slowdown leaving the barrels unwanted.
Given the price weakness seen since the announcement, a back-of-envelope calculation shows the need from a Saudi perspective for a ten-dollar rally in crude oil for the one million barrels cut to be revenue neutral. Saudi Arabia normally lowers exports during the summer months to meet higher demand at home, so revenues will take an even harder hit, but at the same time even lower exports should help stabilise and eventually send prices higher.
OPEC’s focus on supply management will likely enforce the view of a soft floor under the market, however, whether it is $70 in Brent or even lower remains to be seen, but a major drop is seen as unlikely. The upside potential, seem equally unlikely as long the focus remains on a weakening economic outlook. From a technical standpoint, the $78 to $80 area in Brent will likely offer a great deal of resistance and funds positioned for additional weakness are unlikely to change their negative price view until we see the return of an 8-handle.
Much has been said about speculators, especially the dislike by oil producers for this group of traders that involve anything from small family investment office to large hedge funds and CTA’s. Funds in this broad group trades different strategies, the most common being either a macro-economic focused or a pure price driven strategy where momentum and technical analysis determine entry and exit levels. More often they are followers instead of drivers of markets, buying into strength or selling into weakness until the technical and/or fundamental outlook changes to an extent that warrants a reduction or change in direction. These changes are not done in an instant but are often spread out over several days, meaning that a period of short covering, as seen last week ahead of the OPEC+ meeting, may not change the overall bias, which for many is still to trade the market with a short bias.
The behaviour among the above-mentioned group of traders can be monitored in the weekly Commitment of Traders Reports from the US CFTC. In it the clearing members across the different futures markets must report holdings held by clients above a certain size, for commodities split into four major categories; Producer/Merchant/Processor/User, Swap dealers, Managed Money and Other Reportables. In our weekly reporting we focus primarily on the managed money section but other reportables also belong to the ‘buy-side’ and needs to be considered to get the full picture.
In the week May 30, before short-covering was seen ahead of the weekend meeting, the total speculative net-long position across the five major crude and product futures contracts was 387k contracts, split between a 439k contract combined net long in Brent and WTI crude oil and a 52k contract net short in products, primarily due to a 118k contract short in gas oil.
Overall, the total net long, as per the chart below, is near the lowest level in more ten years, and it highlight how the market is already close to pricing in a worst-case scenario, and from here we see an increased risk of length starting to rebuild. But as mentioned, speculators are not those selling the peak or buying the through, and it would take a change in the mentioned technical and/or fundamental outlook for that to change. According to this assumption speculators will eventually become a supportive driver for prices and once that happens help support Saudi Arabia’s quest for higher prices.
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