Macro: Sandcastle economics
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Crude oil: Demand worries return to weigh on prices
Ole Hansen
Head of Commodity Strategy
Summary: The energy sector is experiencing ongoing consolidation, influenced heavily by concerns over potential US rate hikes and an uncertain outlook in China. As China is the leading importer of crude and the primary force behind demand growth in 2023, its impact on the oil market cannot be understated. Similarly, Saudi Arabia's role in the supply side is crucial, especially with their voluntary production cut of 1 million barrels per day, which has been instrumental in recent price surges. Thus, for insights into the current oil market, it's essential to closely monitor developments in China for demand and Saudi Arabia for supply
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Global Market Quick Take: Europe
The energy sector, excluding natural gas, has rising strongly this quarter with sentiment experiencing a major positive turnaround as aggressive voluntary production cuts from Saudi Arabia continues to tighten the market. In addition, concerns about the global economic outlook have yet to impact demand in any meaningful way, and together these two developments have seen WTI and Brent reach four-month highs.
Just like last year, when prices shot higher following the Russian invasion of Ukraine, the rally has been led by tight diesel markets which have sent prices for gas oil futures in London and Ultra-light Sulphur Diesel (ULSD) in New York surging to $123 and $131 dollars per barrel, the highest levels since January. In WTI crude oil, the premium the prompt futures contract, currently CLU3, commands over the next has reach a November high around 70 cents, and the tightness or backwardation of this magnitude has been adding to the bullish sentiment.
Overall, the current market tightness remains on clear display through the elevated backwardation shown across the time spreads, an example being WTI which has seen its front month spread rise from a 10 cents discount (contango) in late June to a current 45 cents premium, albeit down from 75 cents earlier this month. Among the major commodities, the energy sector continues to command some of the highest backwardations as seen below through the twelve-month spreads below. They show Brent and WTI trading around 6% above their respective one-year forward prices, with gasoil, given the recent diesel tightness, somewhat higher near 15%.
The latest Commitment of Traders report covering the week to August 8, showed a near unchanged combined hedge fund long in WTI and Brent futures, at 421 million barrels, six weeks after the net long reached a three-year low at 231 million barrels. As we noted in our latest update, the bulk of the buying during this time has primarily been driven by shorts being bought back, and not fresh longs entering the market. It highlights a certain hesitancy about extending positions beyond current levels amid the risk to demand and, not least, the potential risk of financial and politically driven supply restraints being reversed.
Later today, the EIA will publish its weekly crude and fuel stock report and the market is potentially looking for a bigger than expected crude stock reduction after the American Petroleum Institute last night reported a 6.2 million barrels draw versus 1.7 million expected. Traders will also be watching changes in gasoline and diesel stocks as well as exports, refinery activity and production estimates.
In Brent, a close below the 21-day moving average, currently at $84.38, will be needed to signal a pause in the bullish momentum that has prevailed since late June. A break could open for a move towards the 200-day moving average line, which is currently offering support at $81.25, while above the market, a band of resistance exists between $87.50 and $89.
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