Cycle of Tightening is Nearly Complete
The major factor behind the latest run up in oil prices is undeniably the Saudi determination to draw down global oil inventories by voluntarily constraining production. On Wednesday and yesterday timely help arrived from the economic front and from the European Central Bank. Although US headline inflation rose in August, the core figure moderated. It foreshadows a possible pause in interest rate hikes from the Fed next week although it will likely leave the door open for a last hurray in November depending on incoming data. The ECB executed its 10th consecutive increase yesterday and downgraded its growth forecast for this year and next. As downbeat as it sounds, the bank also implied that borrowing costs have peaked. All these, coupled with China cutting reserve ratio, sent equities higher also providing additional ammunition for oil bulls and they were not shy to use it. Overnight support also comes from the Far East as growth in Chinese industrial output and retail sales bettered forecasts.
So, oil inventories are plunging, and interest rates have plausibly reached their peaks or are very close to that. What’s to worry about? It has been intriguing to observe the tangible influence of oil on economic data. US headline CPI rose because of strong retail gasoline prices. The same goes for producer prices. US wholesale inflation was higher than expected last month due to elevated energy costs. Retail sales in the world’s biggest economy beat expectations because, yes, you guessed it, spending on fuel jumped considerably. Whilst the outlook for soft landing without seriously harming economic growth have clearly brightened in the recent past, incoming data reveals the impact energy prices have on inflation. The pessimist would argue that something will have to give in the not-so-distant future. Either oil prices will have to come lower so the encouraging pull back in consumer and producer prices continues broadly unabated or inflationary pressure will start ascending again forcing monetary policy makers to keep the cost of borrowing high for much longer than currently anticipated or even hike it again effectively hindering expansion and denting oil demand. For now, nevertheless, optimism prevails.
Paralysed by Price
It is only right and proper that the oil market goes through a period of navel gazing after the recent stellar rally it has put in. The relative strength index (RSI) over a 14-day period on both WTI and Brent are registering above 70 and overbought and if chartists were still using graph paper with line and figure marks drawn by pencil, the numbers would be going off the page. A relay rally is precluding bear traders from expressing personal persuasion because if it is not distillate that rallies, it is crude, and when either appear to show any sign of exhaustion the other steps in to take up the reins of the rally.
Coming in at time when refinery turnarounds are on the lips of all oil watchers is an intriguing research piece from Bloomberg. Collation begins from 2019 and is compiled from TomTom data and tracks the changes in global congestion by region. Why this is important for oil is that in the main, higher congestion signifies greater vehicular use and refined fuel demand. In truth, it should not be surprising that post-summer, lives, and traffic are returning to the normal rhythm of a working week after experiencing a seasonal slowdown, but it comes at a time when the market is sensitive to all motor fuel use. On a regional basis congestion showed the following changes: APAC ex-mainland China +5.5% week-on-week and +3.4% year-on-year, Europe +11.9% week-on-week and +0.8% year-on-year and North America +18.7% week-on-week and +1.8% year-on-year. Incidentally, and running counter to the idea that everything China is bearish, its congestion was up 13.1% from the previous week. Bulls, drawn in by continued product demand copy, greet such stories as confirmation in thinking.
Bears have for some time been able to rely on a global macroeconomic environment that has shuttered the progress of oil’s rally until recently. But the success of the Saudi/Russia axis in tightening crude supplies as acknowledged by all three-monthly reports of the EIA, IEA and obviously OPEC, have muted such effects. Oil has also seen a change in relationship with the US dollar. This is worthy of a study in the future (which we will undertake), but briefly and entirely arguable is that the US’s role as the world’s swing producer and largest exporter changes its trade balance dynamic. For the sake of convenience and brevity, July 13 this year saw the US dollar index (DXY) trade at 99.77, as of September 14 it was 105.40. Using the same date ranges M1 WTI has travelled from 76.89 to 90.16. Does this mean the inverse relationship has altered? It is too soon to tell, but a major inhibitor in oil price strength is currently being kept behind by the macro-classroom teacher and in punishment having to write the lines, ‘I do not want to be a petro-currency'. There is little to indicate that the US Federal Reserve will change rates next week, the CME FEDwatch tool has that there is more likely to be a rise in November. However, it does not mean that oil prices will not feel the jitters of the wider suite even if the US dollar’s influence is at present diminished.
Oil’s rally is no spike or flash news driven. It has had to work for the success and the price increase, depending on when one starts a track, is nigh on sedate. This can be seen by how volatility in prompt, at the money options in Brent was 23% one month ago and remains the same at the London mark COB last night. Does this conservative action and benign volatility indicate a greater chance of a prolonged rally? In some ways yes. But oil’s eventual destination in price is completely governed by how the refinery turnaround conundrum is answered. It will be very interesting to see Commitment of Traders reports next week and if the market has received late-coming length. A market that is overbought and is at psychologically emotive levels does not always bring about a correction, but it will bring a reluctance for bulls to add additional length.
15 Sep 2023