Anyone pondering on the extent of the geopolitical risk premium built in the price of oil due to the Middle East crisis got a strong hint between 5 and 5.30 pm London time yesterday when Brent dropped more than $2.50/bbl in the space of less than 30 minutes due to rumors that a ceasefire had been agreed by Israel. In effect, what happened was that Hamas received a truce proposal, which includes the release of hostages but has not countered yet. The sharp drop then quickly reversed only for prices to weaken again towards the close.

The violent market reaction is understandable. There is, the thinking goes, no smoke without (cease)fire and unless an unequivocal rejection surfaces from either of the warring party investors will be very cautious to commit themselves to the upside. Having said all that, it is imperative to re-iterate that the hostilities between Israel and the Hamas and the resultant disruption of shipping through the salient Suez Canal artery have not reduced oil supply, they have made it more expensive. The global oil balance has not gotten tighter therefore however painful and vicious an ostensible sell-off might turn out to be it could prove short-lived. Prior to the breakout of the conflict last October Brent printed $84/bbl.

The so far unsubstantiated rumor, briefly circulated by Al Jazeera, or one might call it the progress towards peace, spoiled what was destined to be the return of a healthy risk appetite. After all, rate cuts are getting ever so closer as inflation has been tamed in critical economic hubs. Euro zone inflation edged slightly lower; the BoE kept rates unchanged, but consumer prices only rose 2.9% last month strongly provoking the 2% target and, in the US, new jobless claims rose helping to curb wage inflation – much to the delight of the Federal Reserve.

Russian product exports are likely to fall substantially in November from Tuapse as domestic supply is given priority after several drone attacks on refiners. OPEC+ will wait until March to decide on a possible production increase. The US approval of striking Iranian targets in Iraq and Syria does nothing to alleviate tension in the region. Yet, crude oil prices dropped around $2/bbl with the WTI structure coming under additional, albeit probably temporary, attack from BP’s shutdown of its Whiting, Indiana refinery because of a power outage. It is simply impossible to foresee whether the proposed truce will turn into an actual ceasefire; what seems beyond doubt is that notwithstanding the several other factors that usually shape investor sentiment the next $5/bbl move will be predominantly decided by developments in the Middle East. Given the perpetual and deep-rooted acrimony between the adversaries it will take more than just good will and common sense to put pen to paper.

Rosy Economic Outlook - IMF

The Washington-based International Monetary Fund, the traditional multilateral lender of last resort, published its updated global outlook on Tuesday. It paints a sanguine picture. The narrative was hopeful in that ‘soft lending’, ie. coming out of economic turmoil without pushing the global economy into recession, is plausible and achievable. The Fund’s chief economist, Pierre-Oliver Gourinchas, pointed to the resilience of the global economy in the face of recent inflationary pressure as the major reason for the upbeat projection. Public and private spending has proven to be strong; supply chain bottlenecks have considerably eased resulting in steadily abating increase in consumer prices. Although the outlook has brightened, the IMF emphasized global economic expansion and trade will remain below the historical average.

Global growth is now seen at 3.1% in 2024, 0.2% higher than in the October World Economic Outlook. The main culprit behind this buoyant view is almost single-handedly the United States, whose economy is now seen expanding 2.1% in 2024, up from 1.5% seen in October and 1% predicted in July. It is, indeed, a remarkable feat, which is the collective result of the incumbent administration’s stimulus programmes that came in the form of the Inflation Reduction Act and the CHIPS and Science Act, substantial pandemic-induced household savings finding their way to the market and optimistic investor sentiment, partially fueled by the astronomical rise in AI as reflected in the relentless march higher in the Nasdaq Composite Index.

In other parts of the developed world the picture is less encouraging. Growth in the euro zone is expected to moderate to 0.9% this year, down from 1.2% in October and 1.5% in July. The same way as the US greatly contributes to healthy global growth, Germany impedes expansion in the common currency area. Its economy will expand by a feeble 0.5% in 2024, which is a considerable downgrade from last July’s estimate of 1.3%. Undoubtedly, the market will react sensitively to any changes in Germany’s outlook prospects going forward.

Emerging markets will grow by a respectable 4.1% in 2024, which matches last July estimates but a tad higher than in October. What might come as a surprise in this group is the massive upward revision in Russia’s growth and the more than auspicious backdrop in China. The GDP of the former is to expand by 2.6% in 2024, up from 1.1% seen in October due to a stronger-than-expected growth in 2023 as a consequence of high military spending and private consumption. Chinese 2024 growth has been revised up by 0.4% to 4.6% for the same reason as Russia’s. Last year its economy strengthened faster than anticipated due to increased government spending and capacity building against natural disasters. India’s admirable growth rate of 6.5% is 0.2% above the October estimate.

Looking further ahead, the global economy will see an expansion of 3.2% in 2025, unchanged from October. Both the US and the euro zone will grow by 1.7% with emerging markets expanding 4.2%. This includes China and India growing by 4.1% and 6.5% respectively. These updates come with caveats and warnings and justifiably so. Major factors that could upset the rather favourable global economic backdrop include commodity price spikes due to geopolitical shocks, the resultant supply disruptions, persistent inflation, and the consequent protracted tight monetary conditions. The frail Chinese property sector could also lead to amendments of the present view.

Positive economic outlook leads to healthy global oil demand, nonetheless, complacency of expecting considerably higher oil prices might backfire. Subsiding inflation is an unreservedly welcome development, but it is worth remembering that borrowing costs, albeit peaking, are still high and they have a conspicuously adverse impact on aggregate demand and therefore oil demand growth. Hence the pragmatic IMF view on oil prices, which are expected to average 2.3% under 2023, ie. $82.28 basis front-month Brent and another 4.8% lower in 2025 at $76.43/bbl. These forecasts broadly match the current curve – or at least they did until yesterday’s plunge. Curiously, the latest Reuters poll found that Brent ought to average at $81.44/bbl this year, reassuringly close to yesterday’s curve and to the IMF estimate. It is a uniquely strong consensus, which also carries the message of optimism that the healthy economy will support oil, but it does not sow the seeds of rally above $100/bbl barring the Middle East engulfing in flames.
 

Overnight Pricing

tamas.varga@pvm.co.uk

© 2024 PVM Oil Associates Ltd