The impressive late bounce from yesterday’s initial weakness and this morning’s continuous climb in oil prices serve investors with a reminder of the risk that is rooted in the ever-growing tenson in the Middle East. Without the ongoing atrocities around the Red Sea oil prices would have finished the day considerably lower. To begin with, equities were sold off and so were bonds as yields rose yesterday. The culprit is one of the Fed’s favourite measures of economic health, the labour market. Simply put, it is still tight. The number of those filing for unemployment benefits fell more than anticipated last week and private employers hired more workers than expected last month. Hopes for an early rate cut suffered an inevitable setback with all the consequences on stocks and bonds.

Although the EIA reported a considerable 5.5 million bbls drawdown in crude oil stocks as exports reached 5.3 mbpd last week, partly due to the frequent attacks in the Red Sea, the more than 10 million bbls increase in gasoline and distillate stockpiles was enough to cause a mini tremor amongst those with bullish propensity, especially when the more than 2 mbpd plunge in weekly proxy demand is also considered.

They, however, quickly re-gained confidence as the impact of the weekly US oil stats faded and focus shifted back to the events in the Middle East. In an attempt to prevent further escalation of the conflict the US Secretary of State is planning to travel to region again where anxiety remains at an elevated level after the killing of 100 people at a ceremony in Iran and as Israel is preparing further assault in the north of Gaza in its pursuit of Hamas leaders. Maybe further upside potential is limited because actual supply disruption has not materialized but the widening backwardation in the European benchmark clearly signals considerable concerns amongst traders about the spread of the conflict to the wider region.

Underperforming Oil

In Wednesday’s note we outlined the potential factors that could shape investors’ sentiment in 2024 and we concluded that the major drivers will be those that had an undeniable impact on asset prices in 2023: geopolitical and geoeconomic developments, interest rates and the dollar, China and its economic performance, OPEC+ and non-OPEC+ production and supply and the transition from fossil fuel to renewables. Analyzing the annual returns of different asset classes could be considered the same exercise but from a different angle and the results are also telling.

The bottom line is that oil underperformed other assets in 2023. On a front-month basis the five major oil futures contracts all lost value. WTI and Brent were the least disappointing with a negative 10% return followed by RBOB at -14%, Gasoil -18% and Heating Oil -25%. Curiously, when monthly rollovers are taken into account the performance improves meaningfully. Arbitrarily using the first trading day of each month to move length from one month to the next one realizes that there was money to be collected from the structures as on average backwardation persisted throughout the year. The extent of it was around $25/bbl equivalent on Heating Oil and Gasoil, $19/bbl equivalent on RBOB, $6/bbl on Brent and a mere $2/bbl on WTI. The contradictory relationship between the movement of outright prices and the structure neatly sums up the uncertainty surrounding oil trading last year. The biggest flat price losers, Heating Oil and Gasoil claimed back the greatest part of these losses with comparatively wide backwardation. The difference between the benefits of rollovers between Brent and WTI reflects the high geopolitical risk over 2023. On a net basis, RBOB was the star performer as it returned 4 cents on every dollar last year with Gasoil doing a tad better than breaking even (+0.65%). Brent lost more than 3% including rolls and WTI and Heat both produced a negative return of just over 7%.

Equities, on the other hand, proved to be tempting investment vehicles last year. The astronomical increase of the Nasdaq Composite Index is a true reflection of the growing popularity of the Artificial Intelligence sector amongst investors – it returned 43% last year. The performances of the rest lagged somewhat but they were also attractive, nonetheless. The S&P 500 index rallied 24%, the Japanese stock market climbed 28% and the MSCI All-Countries Equity Index finished 2023 20% higher. In general, stock movements last year unmistakably imply confidence that global efforts from central banks to defeat inflation have been successful, something that is also embodied in the bond market. Although the 10-year US bond yield crawled higher year-on-year the spectacular retreat from 5% in the middle of October to below 4% by the end of the year is a clear indication of the sanguine mood.

There were warning signs, however. The Chinese economy was stuttering. The Shanghai Composite Index finished last year 3.7% in the red and no doubt it will be eagerly followed in 2024 for signs of recovery or further headwinds. It will have a tangible impact on the view on oil demand. Not much should be read into the 12% gain observed in the Russian stock market. Wars never lay down the foundation of economic prosperity and last year’s positive return was chiefly the function of capital controls and trapped domestic investors being forced to put their money into Russian stocks. The picture is more realistic when the year-on-year weakening of the rouble is added to the equation. In dollar terms Russian equities fell around 13%.

Generally healthy optimism about the global economy usually foretells auspicious oil demand expectations. Last year was no different. Worldwide consumption of the black stuff reached a record high of 101-102 mbpd depending on which forecaster is to be believed and further gains are penciled in for 2024. It then logically means that sluggish showing of the oil complex was the result of ample supply last year, something that is expected to continue in 2024. Of course, unexpected economic turbulence could always lead to downward revisions in oil demand, the perceived or actual changes in production, whether caused by geopolitical developments, OPEC+ action or non-OPEC+ resilience, will plausibly remain the main price driver in the year ahead.

tamas.varga@pvm.co.uk

Overnight Pricing

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