Crude oil: Supply constraints and record demand
The energy sector, including natural gas, has risen strongly this quarter with sentiment experiencing a major positive turnaround as aggressive voluntary production cuts from Saudi Arabia continue to tighten the market. In addition, concerns about the global economic outlook have yet to impact demand which, according to the IEA, hit a record and could move even higher in August, potentially prolonging the current rally until OPEC decides to increase production by tapping into the an estimated 5.7 million barrels a day of spare capacity.
These developments have seen WTI and Brent reach four-month highs, and 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 respectively per barrel, the highest levels since January. In WTI crude oil, the premium the prompt futures contract, currently CLU3, commands over the next month reached a November high and the tightness or backwardation of this magnitude highlights the current bullish sentiment.
According to IEA’s latest Oil Market Report, global fuel demand averaged 103 million barrels a day for the first time in June and may soar even higher in August. With Saudi Arabia and its OPEC+ partners keeping supply constricted, the market looks set to tighten further, resulting in a 1.8 million barrels a day deficit during the second half.
Crude oil production from the OPEC+ group of producers fell to a two-year low in July according to the latest Platts OPEC+ Survey carried out by S&P Global Commodity Insights. While OPEC pumped 27.34 million barrels/day, non-OPEC allies produced 13.1 million barrels/day, with the bulk of the reduction being driven by Saudi Arabia’s aggressive voluntary production cut which has so far been extended to include September. The one million barrel a day cut has seen the Kingdom’s production slump to a two-year low and some two million barrels below what it pumped last September.
At the beginning of June managed money accounts held a 231 million barrel combined net long in Brent and WTI, and apart from the March 2020 Covid-19 outbreak slump, this was the lowest confidence in higher prices since 2014. However, following the Saudi cut and the energy ministers' vocal threat to hurt speculators, a six-week buying spree unfolded and according to the latest Commitment of Traders Report covering the week to August 1st, it helped lift the combined net long by 82% to 421 million barrels. Looking into the numbers we find the bulk of the buying (61%) has been short covering, and despite having seen prices rally by more than 15%, it highlights a hesitancy about getting extended on the long side, especially when the bulk of the tightness has been driven by a politically motivated production cut. With this in mind, we keep our Q3 outlook that sees limited risk of a sustained move above $90.
In Brent, the key level of support can be found around the 200-day moving average, currently at $81.54, while some resistance has emerged ahead of the January high at $89.