The optimism about the health of the global and US economy appears unbroken. A Fed rate cut in September is fully priced in with a split of 25%/75% for 50bps/25bps, the CME FedWatch tool implies. Equities are rallying. The Nasdaq Composite Index gained 14% since the early August low including yesterday’s advance of 1.39%. The MSCI All-Country Index has returned 9% in the last two weeks. Today’s euro zone CPI data and this week’s get-together of monetary luminaries in Jackson Hole is expected to confirm that inflation has been reined in and the lowering of borrowing costs is to become ever more prevalent.

In this economic climate the weakening of the dollar is anything but surprising, yet what we see is that oil has decoupled from other risk assets. Brent has fallen more than $5/bbl in a week only to be beaten by RBOB with a loss of 8.4/bbl equivalent. The main culprit is China, whose economic struggles are mirrored in falling product exports figures, sluggish refinery runs and waning thirst for foreign crude oil. Consumers are not spending, yet the communist leadership seems reluctant to provide much needed support to ameliorate economic conditions and left the pivotal one-year loan prime rate unchanged. Israel’s alleged willingness of negotiate a truce with Hamas undeniably contributes to the sour mood but currently China is the salient price driver. Although its misfortunes and economic mismanagement will not have a perennial negative impact on sentiment as there are other factors to be considered (interest rates, OPEC+ production etc.), it will certainly set a limit how far oil prices can rise when the inevitable price reversal gets under way. 

Dark Demand Clouds

For the past few months, we have been of the view that oil prices should peak around $90/bbl in the second half of the year basis Brent and will not meaningfully challenge the April peak of $92/bbl. This assumption was based on the supply-demand balance scenarios presented by the three major agencies and whilst absolute figures diverge meaningfully, the annual changes both on the supply as well as on the demand side of the equation insinuated limited upside. The latest set of data published last week did not only re-enforce the view of concerns of a significant rally but also hinted at an ominous picture for the last quarter of the year and for 2025.

There are three seemingly constructive factors that those with bullish propensity use as a reason to remain sanguine about the future. The first one is macroeconomy. Admittedly, there is an increasing likelihood of recession, both global and US, being avoided. This is leading to cuts in borrowing costs. As supportive as it sounds, any jump in oil prices will re-ignite elevated growth in consumer prices capping these rallies. A Fed rate cut, when it comes, will weaken the dollar, which is deemed oil-price friendly, on the other hand it should embitter investors’ mood in the US equity markets, which have produced stellar returns, so far this year. Falling stocks could adversely impact oil. Secondly, the geopolitical risk premium remains inflated because of Ukraine’s incursion into Russian territory and the increasing hostility between Iran and its arch enemy, Israel. There has, however, been no considerable supply disruption either from Eastern Europe, or from the Middle East. The occasional rise in geopolitical temperature has not been able to provide protracted oil price support. Thirdly, the OPEC+ resolve to tighten the oil balance is also seen as positive. The details to watch on the supply side of the oil equation is the adherence of overproducers to the pledged compensation scheme and the decision to go ahead or not with the promised unwinding of the 2.2 mbpd voluntary cuts starting October this year.

The latest set of monthly data showed no dramatic amendments in the 2024 oil balance, yet what is discernible is an increasingly gloomy view on oil demand for the last quarter of this year and for the whole of 2025. Both the EIA and the IEA downgraded its 4Q 24 estimates on global oil consumption, by 140,000 bpd and 200,000 bpd respectively. OPEC left it unchanged but curiously it cut its 2024 projection by 150,000 bpd. There was no anomaly for next year. All three of them now see less demand for oil for 2025 than the previous month, 120,000 bpd on average. Fingers are pointed at China. The theme that underpins the updated forecasts is that whilst demand prospects from developed nations is still upbeat, the outlook for the world’s second biggest economy has worsened. The IEA emphasizes that Chinese oil demand has contracted for the third consecutive month in June. The country will be responsible for 31% of the total 2024 demand growth whilst the same figure for 2025 crawls up to 44%. As a comparison, two months ago, China’s share of total oil demand growth stood at 50% for this year and broadly the same as this month for 2025 but latest economic and industrial data suggests that this proportion will deteriorate in coming months. The moral of the story is that China is a drag on demand outlook and consequently on the tightening of the oil balance.

Notwithstanding the grimmer demand outlook, the call on OPEC+ oil remained unchanged for 4Q 2024 but was cut by 80,000 bpd (IEA) and by 230,000 bpd (OPEC) for 2025. (The EIA left it unchanged.) For the last three months of 2024 demand for DoC oil will advance by 200,000 bpd on the quarter, the EIA and the IEA reckons with no change according to OPEC’s estimate. Whether global stocks will deplete at a faster-than-anticipated rate depends on the adherence on the compensation plan and on the action OPEC+ will take concerning adding the 2.2 mbpd of supply back to the market. Next year is unreservedly bleaker than believed even a month ago. Considering the sacrifice OEPC+ has made in the past two years, and given the lax compliance of some member countries, including Russia that needs to sell as much oil as it can in its effort to finance its war, further practical belt-tightening is not impending from the alliance. Our recent view of topping out at $90/bbl is consequently revised and overcoming the July summit of $88/bbl, whilst approaching it cannot be ruled out, does not seem a realistic proposition in 4Q. The ubiquitous view on demand deteriorations in tandem with OPEC+ staying put or maybe even increasing output will ensure that the average oil price for 2025 will be cheaper than for the incumbent year.

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