As anticipated, markets were relatively slow and subdued yesterday, since the US celebrated the harvest feast from more than 400 years ago shared by the Pilgrims and the Wampanoag people. Other parts of the world, however, did not rest and the result was a slight uptick in prices. It was partially the product of mutual accusations from Israel and Hezbollah of violating the ceasefire agreement that came into effect Wednesday morning. It is a clear sign of the fragility of the truce. Still, it will not have a tangible impact on the supply of crude oil from the region—Russia’s intensifying strikes on Ukrainian energy infrastructure raised concerns of further escalation of the conflict. Although OPEC+ decided to delay their Sunday meeting until next Thursday because of the get-together of the Gulf Cooperation Council on December 1, the general view is that the alliance will extend its output cut beyond January.

No Disruption from the Middle East, No Joy for Refiners

Every time the thermometer that measures geopolitical temperature changes, the debate about the extent of the risk premium intensifies. Take the latest example from the beginning of this week. When the possibility of a ceasefire between Hezbollah and Israel was floated on Monday afternoon the price of Brent dropped more than $2/bbl in the space of 3 hours. Allegedly, the decline was entirely the function of the reduction in supply risk surrounding the tense Israeli-Iranian relationship. Some argued that the risk premium almost completely evaporated whilst others reckoned that the animosity in the region keeps simmering on or slightly under the surface. It is an impossible task to accurately measure risk premium, but we suspect it never falls to zero. Those who are prepared for every eventuality, always set aside a portion of their funds, however tiny it is, in case sanctions are imposed on Iran, the Strait of Hormuz is shut, Saudi oil installations are attacked, or Libyan factions are at each other’s throats again. History of the past 2,000 years, religious confrontations and the fact that the Middle East sits on vast oil reserves almost predestines the region to periodical spikes in tension, therefore this pragmatic approach is not only reasonable but also justified.

The latest truce will hopefully hold, notwithstanding yesterday’s reciprocal accusations of breaching it. Yet, when it was announced, it only had a brief negative impact on oil prices. The logic is unquestionable. Oil supply has been re-directed but not cut since the abhorrent Hamas attack on Israel last October and the ensuing and possibly disproportionate Israeli retaliatory measures. Monday’s sharp price fall, therefore, must be attributed to the liquidation of some length, most plausibly by algorithmic trading models that initiate actions when they recognize keywords, such as truce and Israel or the Middle East. It was not due to growing concerns of additional supply. It leads to the dilemma of whether the continuation of the move lower is impending, or we might see a price reversal, even if the agreement does not fall apart. After all, the global oil balance remains unchanged and there is no reason not to re-test the recent peaks.

Conventional wisdom says that the current price is always the prevailing ‘fair price’ but given the financialization of markets, the almost continuous rise in trading volumes, the herd mentality and the infamous phenomenon of FOMO, the reaction to developments tend to overshoot what is deemed the ‘fair price’ - admittedly a subjective phrase. A more reliable barometer of market sentiment is assorted spreads, on the physical as well as derivative stages, since they are faithful reflections of the underlying oil balance, the ultimate and long-term price driver. For this reason, it is useful to revisit the topic on a regular basis and form a view on the price direction based on the changes in spread values.

The first development that catches the eye is the backwardated structures of the two major crude oil futures contracts, WTI and Brent. At around 30-40 cents/bbl (concentrating on the February/March Brent spread given today’s expiry of the January contract) one might conclude that the crude oil market is strong(ish) as these values are way above the long-term averages. Yet, they are well under what might be deemed a genuinely tight market, such as the backwardation of $1/bbl observed in April this year. More intriguingly, perhaps, Brent CFDs, the price difference between cash and forward Brent shows a massive premium of $1.15 for next week, our crude oil desk estimated last night. If anything, the crude oil segment of the market implies upside bias.

Products, or better say, crack spreads, paint a slightly unenthusiastic picture. The price difference between refined products and crude oil, the profit refiners realize after selling the stuff they make out of crude oil, is depressed. Crack spreads are reluctant to rally. On the CME, the 3-2-1 crack is stuck in the $15-$19/bbl range compared to $25/bbl a year ago. Gasoil received a temporary weather-induced boost also supported by a frisky natural gas market but the front-end backwardation that widened to above $8/tonne mid-week has retreated to $5/tonne with the Gasoil/Brent crack unable to make significant headway above $20/bbl and is some $10/bbl cheaper than during the comparable period of 2023. Judging by disincentivized refining margins, supply is more than sufficient to satisfy whatever demand is out there.

Sporadic flare-up in atrocities in the Middle East and a brief re-appearance of freezing temperatures could put oil prices on an upward trajectory once again. Next year, however, the growth in non-OPEC+ supply will outpace the increase in global oil demand, according to the IEA and the EIA. OPEC has a diverging view, which goes against its own action of keeping production cuts in place. On balance, the updated snapshot insinuates that next year promises to be looser than the current one and oil prices are to average below the 2024 level. We expect Brent to break under $70/bbl and approach the $60/bbl as the seasonally weak 1Q-2Q period approaches.

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