Fears of supply disruption from Canada and geopolitical risk premiums from the Middle East and Ukraine were on the back burner yesterday. The oil fraternity cast its eye over US oil inventories and the threat of growing supply. Proxy demand for US gasoline and distillates showed weekly declines of 1.2 mbpd and 740,000 bpd. No surprise then that stockpiles in both products ballooned firmly aided by the 3.1% rise in utilization rates. When refiners step on the accelerator crude oil stocks tend to plunge. That was precisely the case last week, but this draw was far from sufficient to compensate for the massive increase in product inventories. The moment the weekly EIA statistics were released investors kept pressing the sell button, undeniably incentivized by the cut in the Saudi July OSP to Asia and by a report from Bloomberg that the Kingdom will push for a minimum of 411,000 bpd increment in output both in August and September – effectively completing the unwinding of the 2.2 mbpd of voluntary constraints.

To label yesterday’s move down as the beginning of the end of the rally that started in May would be a bold statement. Oil did its best to recover from the EIA-triggered sell-off, and help arrived from obstinate equities. Stock markets casually ignore the black clouds gathering above them, the latest additions of which were the unforeseen contraction of the US service sector last month and declining economic activity as detailed in the Fed’s ‘Beige Book’. The main topic below attempts to provide an answer to whether the current buoyancy is sustainable.

Ebullient Present, Bleak Future

In the light of latest developments, one might wonder why oil prices are as resilient as they are. The adverse consequences of a global trade war are still deemed the sword of Damocles for risk assets. If it creates economic turbulence, it will inevitably depress oil demand and oil demand growth. Non-OPEC+ producers have been happy to fill the void left by OPEC+ when they decided to withdraw nearly 6 mbpd of production since 2022. Frustrated by lost market share and by the lack of meaningful upside price potential, the group, or its juggernaut, decided to release barrels back to the market faster than anticipated. And yet, what has been on display is an advance of around $6/bbl from the low of $58.50 at the beginning of May, based on Brent.

The broader picture, however, is not as sanguine as the recent price jump implies. Since President Trump started his second term in January, oil has been getting cheaper. Brent was printing $83/bbl before Inauguration Day and has shed around 20% of its value in six months. Clearly, investors’ anxiety about Trump-induced recession and/or inflation leaves its mark on the outright price movements. What is, nonetheless, noticeable, is that notwithstanding these tangible worries, assorted spreads or price differentials are remarkably and reassuringly stubborn.

The M1/M2 Brent price differential is in a backwardation, despite the considerable drop in outright price. Conventional wisdom says that the structure of a futures contract in oil positively correlates with flat price movements. Whilst this relationship evolves all the time and is not set in stone it is intriguing to observe that the M1/M2 Brent spread correlated with the front-month contract to the extent of 52% in 2024. This connection has conspicuously broken down and has fallen to 15% since mid-January.

The same phenomenon is perceptible in crack spreads. On the CME and ICE, the major product contracts, Heating Oil, RBOB and Gasoil have all retreated in the past six months, but the front-end backwardation impressively persists on all three of them. Although seasonality is a more impactful factor in product structures than in crude oil, crack spreads also suggest that the market is in decent shape. The CME 3-2-1 crack spread is about $6/bbl stronger (although lost a dollar yesterday) than on January 15 when outright prices were higher. The Gasoil-Brent price differential on ICE is also solid and is matching the mid-January price level. The updated IEA global indicator published last month covering the period up to April 2025 finds that margins in the major hubs of the world, the US Gulf Coast, the Midcontinent, the Mediterranean, Northwest Europe and Singapore, are generally stronger than a year ago, regardless of whether light, sweet or medium, sour cracking is in focus, and unanimously more conducive than in January.

The divergence between outright prices and spreads is attributable to the gapping views of financial investors and the trade – if you believe the mantra, that flat price is more of the reflection of the thinking of money managers whilst spreads better mirror the sentiment in the underlying physical markets. The loss of trust and confidence in US policy making with all its unpropitious impact on the economy and therefore oil demand growth hinders substantial oil prices rise. On the other hand, attractive refining margins create healthy demand for crude oil, which, in turn, helps maintain the backwardation – and amazingly strong Brent CFD values, which, showed dated Brent valued more than $2/bbl over its forward peer lately, but again, retreated yesterday.

In other words, the economic Armageddon envisaged by the US economic, trade and tariff policies has not materialized yet. It is also echoed in relatively low oil inventories. Both the IEA and OPEC reckon that OECD inventories remained below the long-term seasonal average in March. Given that US stocks make up around 45% of OECD stockpiles and they have not increased meaningfully since end-March, this deficit might remain throughout May and may be even beyond.

So, will the presently auspicious fundamental backdrop persevere for the rest of the year, and will our expectations of limited upside price potential prove misplaced and inaccurate? Probably not. The most plausible chain of events will go as follows: soft economic data (consumer confidence, inflation expectations, etc.) will gradually turn into negative hard data, which might have already started in May as flagged in yesterday’s note about global factory activity. It will relentlessly permeate oil demand and when it is coupled with the anticipated increase in OPEC production the oil balance will loosen leading to swelling in stockpiles and putting downside pressure on oil prices. In this perpetually changing economic environment every single data set, headline and prognosis must be followed and scrutinized rigorously but unless President Trump seriously backtracks on his confrontational, transactional and coercive economic policies there will be no need to materially amend the above view. Do you think he will?

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