On the top of every ardent bear’s wish list are a stuttering Chinese economy, relative calm in the Near East and downward revisions in global oil demand growth. These wishes were granted at the beginning of the week, there have been three ticks in the checklist. The sentiment has taken a turn once again, adventurous mentality is being replaced by stone-cold and calculated realism and pragmatism. WTI dived $4.98/bbl from Friday’s settlement, the loss on Brent was $4.79/bbl.

Monetary and fiscal efforts to revive the Chinese economy are proving a damp squib. In their current form, they will not spur aggregate demand and consumer spending, probably the most salient impediments to a brighter outlook on the fortunes of the world’s second-biggest economy. The Shanghai Composite Index has lost 13% from the high of the post-stimulus rally.

Monday night’s report from the Washington Post on Israel contemplating targeting the Iranian military but not nuclear or oil facilities, and the ensuing sharp overnight price drop presented the incontrovertible evidence of what provides occasional price support. Once this support is pulled, there is only one way to go for prices. The US has admonished the Jewish state to ensure the free flow of humanitarian aid to Gaza or bear the consequences of severely restricted military help. Judging by the events of the past year, we suspect it is another red line that Israel will be happy to cross with impunity, in its efforts to achieve complete victory, and we also fear that its attitude towards Iran will harden in weeks to come precipitating sporadic but sharp spikes in oil prices.

Without meaningful disruptions in oil supply, the oil balance will be looser in 2025, chiefly due to demand concerns, particularly from China. The three major forecasters, the EIA, OPEC and the IEA have all downgraded 2024 and 2025 demand estimates. The most significant of these was OPEC’s revision but since its base case was considerably high, it still foresees stock draws this quarter and next year. The end of the current year could actually turn out to be tightish due to healthy consumption readings and OPEC+ constraints, 2025, however, will be much better supplied than 2024 putting absolute and relative downward pressure on oil prices.

The Negligible Impact of Brent NSL

At times of geopolitical turbulence, the risk premium built in oil prices rises. There is no explicit methodology to measure it. Perhaps, examining a change in volatility and comparing it to the change in price is a way to quantify risk premium. At times of relative calmness risk premium erodes, although given the perpetual uncertainty surrounding the political and economic environment, it is reasonable to assume that it never ceases to exist, and a certain amount of funds is always allocated to oil as a hedge against unforeseen eventualities.
There was a tangible rise in output risk in the immediate aftermath of Russia’s invasion of Ukraine, which then quickly subsided when it became apparent that supply would be re-aligned but not disrupted. The same goes for the Israel-Palestine conflict. Without a tangible and adverse impact on supply, the risk premium is mitigated. The chances of Iran being drawn into the conflict rose exponentially after Israel’s offensive against Hezbollah got underway at the beginning of the month, due to the Persian Gulf nation’s retributive missile strikes on Israel and the resultant pugnacious rhetoric from the Jewish government.

The rise in tension, which threatens to affect oil output in the region or the closure of a key traffic artery, has led to significant short-covering and opening of new lengths, particularly in Brent, in an otherwise sceptical market. It is echoed in the drastic change in net speculative length (NSL) in the European crude oil market last week, for the period ending October 8. The impressive rise in NSL was centred on Brent, the rest failed to follow suit confidently.
Combined assets under management in the five major oil futures and options contracts increased almost fivefold on the week, from $4.4 billion to $19.6 billion. More than 60% of this money was pumped into Brent. Its NSL rose from 42 million bbls the prior week to 165 million bbls, having been 12 million bbls net short mid-September for the first time ever. WTI NSL fell by 6 million bbls, and RBOB money managers increased their NSL to the same extent. There was some short covering in Heating Oil and Gasoil but the fact that both contracts have been net short, for 19 weeks and 10 weeks respectively, despite winter knocking on the door on the northern hemisphere, speaks volumes of the state of the underlying physical markets.

Again, the disproportionate rise in Brent NSL is the undeniable function of the Near East antagonism and its potential influence on the oil supply. The recent buying spree based on perceptions and anxiety could escalate if Iran’s oil infrastructure is damaged and retaliatory measures inflict more pain on oil buyers. Under this scenario, Brent NSL will rise further, in tandem with prices. Last week’s Commitment of Traders report, however, also laid bare that no significant upside potential is feasible without physical supply upset.

The rise of 123 million bbls in Brent NSL supported the price of the front-month Brent by $3.62/bbl. It rose from $73.56/bbl to $77.18/bbl between October 1 and October 8. This is uncharacteristically sluggish. When comparing the weekly changes in Brent NSL to its price movement since 2018, one would find that every $1/bbl swing in Brent price equates to a change of 14 million bbls in NSL. Last week an increase of 34 million bbl was needed to push Brent $1/bbl higher. It means that willing sellers were countering the potentially bullish impact of money managers’ enthusiasm. These sellers are found in the ‘Producer’ category. Their net short exposure, combined refiners and crude oil producers, jumped 77 million bbls but gross shorts (genuine crude oil producers), increased by 109 million bbls. It is, therefore, only tempting and even rational to conclude that front-month Brent around $80/bbl is an irresistible price level to lock in a selling price and producers do not anticipate a further increase in risk premium unless all hell breaks loose East of the Suez.
 

Overnight Pricing