Crude correction halted by Russian export ban
An emerging and long overdue correction in crude oil stopped short of reaching its full potential this week after Russia announced a temporary export ban on diesel and gasoline, a move that was driven by consistent high domestic demand for diesel from military forces and farming as the harvest season picks up speed. The ICE gasoil futures contract jumped on the news, dragging crude oil higher with it before losing steam in the realisation that the ban would only last for a few weeks. Russia does not have the capacity to store excess fuel production, and a prolonged ban could force refineries to cut runs thereby reducing demand for crude, which could force a very unlikely cut in crude production.
Meanwhile, Saudi Arabia and Russia’s decision to extend current voluntary production and export cuts until yearend continues to support the market, at least in the short term. The prospect for a large deficit ahead of yearend will offset economic growth worries, especially if the Fed fails to achieve a soft landing, thereby forcing the market focus back to demand and, with that, potential long liquidation from hedge funds that during a two-week period to September 12 increased their combined net long in Brent and WTI by 35% to 527 million barrels, the biggest exposure and strongest belief in higher prices since March 2022.
Most extended right now is the speculative long in WTI crude oil futures, driven by a sixth consecutive weekly drop at Cushing, the world’s largest storage hub and delivery location for WTI futures contracts. Since June, Cushing has seen a 47% decline to 22.9 million barrels, the lowest seasonal level since 2018. One way to measure whether a position is becoming too one-sided is by looking at the long-to-short ratio: during the past month, this has surged from 3.5 long per one short to 14.6, a fifteen-month high. A discrepancy this extreme is no problem while the market rallies but once a reversal sets in, sellers of long position may find it difficult to find bids in the market.
We continue to monitor refinery margins for gasoline and especially diesel as they provide insights into the strength of demand, and when refinery maintenance potentially cuts demand for crude oil.
It was the rejection at $93.75 in WTI, a double-top from October and November last year, which triggered a long overdue correction, and while the Russian export ban on fuels helped arrest the slide, the downside risk at this stage seems limited to the 38.2% retracement of the recent rally (see chart) at $87.60 with the similar level in Brent being $90.60.