At the end of a tumultuous week, it feels as if one had blinked, one would have missed the action. Such is the relief rally in equities that whatever the Nikkei had lost it has since recovered. Are there any lessons to be learned from such roil in the market? Only that with investors in poor humour as to the plight of interest rates, overexposure to certain quarters of investment and a world that gives war signals on a daily basis, these sorts of fluxes will see repetition. Extension of the relief came from a lower-than-expect US Jobless Claims figures, and with the root of the rout coming from US Non-Farm payrolls, better workplace data continues to repair severely dented sentiment. Interestingly, much of the chat initiated from FED members yesterday agreed that the recent equity moves will have no bearing on policy, although there remained an openness to rate trimming.

The improved sentiment and risk outlook also served oil prices well. In such circumstances, bullish drivers become more palatable and none are more important than the state of the Middle East. As much as the United States, Egypt and others talk up ceasefire negotiations, not much seems to quell the belligerence of Israel. Continued bombings in the Gaza strip and overnight targeting of Hezbollah in Lebanon are hardly a statement of peace. This then keeps alight the idea that at some stage retaliatory action from Iran or its proxies cannot be far away. There is also a glimmer from China. CPI year-on-year for July was 0.5% and so was the month-on-month which beat the 0.3% forecasts for both. There was also a better reading in PPI which shrank by -0.8% rather than -0.9%, which is derisory as a driver but with China any port in a storm will do when looking for something not bearish.

History as a Benchmark

A certain sense of calm has been established in financial markets after the recent turbulence caused by the decision from the Bank of Japan to hike rates and by the underwhelming nonfarm payroll data last Friday. Abating fears and anxiety, nonetheless, do not equal with the unconditional reversal of the weakness, as it was laid bear on Wednesday and yesterday. What it means is that after a fierce re-adjustment of positions the potential consequences of events and data that led to the plunge can be evaluated with cool head. These assessments attempt to establish whether the strong Japanese yen poses any danger to the country’s economy, if the tech bubble has burst or about to do so and finally if the Federal Reserve will stick to its modus operandi and base its decisions on interest rates on incoming data, rather than reacting to sudden and adverse market movements.

Conventional wisdom has it that the equity markets are one of the most reliable barometers of impending economic contraction. Critics would argue that it is a misleading generalization, equity markets must not be confused with the economy and would point to the brilliant observation of the US economist, the Nobel laureate Paul Samuelson, who impishly noted that the stock market has predicted nine of the past five recessions.

Whatever the case maybe, our market is not recalcitrant, it always reacts, follows, and adjusts. The state of the global and regional economies has a palpable effect on the demand side of the oil equation. Wars and geopolitics can and do have an impact on supply and output. The difference between the two is the oil balance, which, in turn shapes inventory levels, the ultimate yardstick of the oil market.

Going as far back as the 2008 financial crisis, it is plain to see that major trends were shaped by the changes in global inventory levels. The devastation, precipitated by the US sub-prime disaster predominantly emerged on the demand side. Oil plummeted from $144 to $36 in the second half of that year with global stocks rising at the rate of 660,000 bpd. (We use IEA data throughout this synopsis.) During the ensuing rally, which lasted until April 2011, oil prices rose to $127 as global demand exceeded supply by 800,000 bpd.

Between 2011 and 2014 the oil market underwent a relative calm with prices fluctuating between $117 and $87 with oil balance broadly in equilibrium but the full force of the emergence of the US shale sector was felt when Brent plunged to $27 by 2016. A demand deficit of 1.5 mbpd prevailed in 2015. As OPEC reached out to producers outside the organization the group’s extended its control on global supply and the resultant rally to around $87 was achieved by a negative 600,000 bpd balance in 2017.

The most extreme scenarios of living memory then took place during the health crisis and Russia’s invasion Ukraine. In the first four months of 2020 the combination of demand destruction and the Saudi-Russian price war pushed Brent down to $16 and WTI much lower with stocks building at the rate of 7.4 mbpd in 1H. The recovery was also quite vicious, the low interest rate environment stimulated demand, which exceeded supply by 2 mbpd in 2021. The Ukrainian war poured more fuel to the bulls’ fire with Brent peaking at $139.

The legal disclaimers at the bottom of every performance table emphasizes that past performance is not indicative of futures results. The same is true for the oil balance, yet the fact that bull markets are chiefly the function of falling global oil stocks and vice versa ought to provide a base line when looking ahead. One might conclude that anyone trying to foretell oil price movements in coming months and years simply has to reliably predict the oil balance for the period. Which is, of course, a much more arduous task than it used to be. The diverging views of the IEA and OPEC are a perpetual point of contention. What is constant, however, is that both expect stock depletion in 2H 2024, the extent of which, admittedly, widely differs. Yet, it insinuates limited downside in oil notwithstanding the recent turmoil in financial markets. The string that is attached to his bold call is that one must be quick and flexible to align his or view to any new reality, which could emerge in the form of sizeable downgrade in global oil demand projections.
 

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