The first day of the latter part of 2024 arrived with a bang. Oil prices rallied hard, front-month Brent was quick to fill the expiry gap left on the continuation chart with backwardation widening both on the European crude marker and its trans-Atlantic peer. More importantly, products performed much better than crude oil, thus crack spread values have improved convincingly. Whether it is the function of brighter demand prospects for refined fuel or market players simply hedging the possibility of refinery disruptions as the hurricane season takes off and Beryl was upgraded to a Category 5 storm is not entirely evident at this stage.

The jump was probably aided by a smorgasbord of manufacturing data. In China the sector shrank, official data showed but the private sector reading showed expansion. Growth accelerated in South Korea, Vietnam and Taiwan but in Europe the underlying trend is somewhat disappointing. The contraction in US manufacturing is an indication of stuttering growth and those who believe in the ‘bad news is good news’ mantra might just turn more optimistic on a September rate cut from the Fed. Jerome Powell’s speech today should provide guidance on the issue. Whatever the case may be, the fact of the matter is that the market is voting with its dollar. There is an unquestionable belief that the oil balance will tighten. Whether this confidence will prove to be a lasting one is discussed below.

Suspiciously Constrained Upside Potential

The world is one big happy place. This is the impression one gets by looking at the performances of different asset classes in the first half of 2024. In case you are wondering the role AI plays in shaping investors’ thinking look no further than the Nasdaq Composite Index, which returned more than 18% in the first half of 2024. The darling of the sector, chipmaker Nvidia shot 150% higher in the first 6 months of the year. The global economy has also been performing seemingly confidently as the MSCI All-Country Index rallied 10% in the period.

And when economic prospects are sanguine oil tends to follow. Out of the 5 major futures contracts traded on the CME and ICE WTI was the most convincing with a jump of 17% followed by Brent as the European benchmark advanced 14%. Even the worst performer, Heating Oil eked out a gain of 5% (monthly rollovers included). The S&P GSCI Energy Index, a composition of the most relevant oil futures contracts, ended the first half of the year with an impressive return of 16%.

The upbeat mood was particularly tangible in June, possibly for two main reasons. Firstly, there was a strong consensus that global recession was being avoided and inflation reined in and therefore interest rates would be lowered in the foreseeable future. Secondly and consequently, oil consumption is seen rising to record highs as the summer on the northern hemisphere gets under way. The groundwork has been apparently laid down for repeating the stellar performances in the second half of the year, something that we are growing increasingly dubious of. The three major factors that influence the price of oil, geopolitics, economy and the supply-demand balance, suggest that whilst further advance must not be ruled out, continuous strength and a serious challenge on the $100/bbl barrier is implausible.

The Near East tension will not peter out anytime soon. After the terrorist attack on Israel on October 7 last year retaliation was always forthcoming and justifiably so but the extent of it appears widely disproportionate. Due to the increasing number of Palestinian death Israel is ever more isolated but determined and Hamas and Hezbollah will not put their weapons down. Yet, what we learnt in the last six months was that neither Iran nor Saudi Arabia advocate escalation, thus oil supply from the regions has not been affected. Russia’s war against Ukraine has resulted in effective drone strikes on the oil infrastructure of the invader causing genuine, but sporadic disruptions to product exports. Further attacks are more than likely, especially that the US Congress approved the $60 billion Ukrainian aid package but their frequency, nonetheless, should remain intermittent. 

The inflationary pressure in major economic centres is gradually, albeit painfully slowly declining, undeniably a welcome development. Central banks of smaller economies, Canada, Sweden and Switzerland, have started to cut rates and the ECB also saw the time was ripe to lower the cost of borrowing. The Bank of England and the Federal Reserve have decided to stay put for now but are leaving the door open for rate cuts. It insinuates alleviating economic hardship. There are, however, several factors to consider before unreservedly betting on unmitigated economic growth. Rising oil prices will increase inflation going forward and re-tightening monetary policies cannot be dismissed. Interest rates, despite being lowered in several countries, are still high historically acting as a brake on further growth expectations. Without the Fed cutting, the dollar will remain strong adversely affecting the economies of developing nations and oil demand. Its index strengthened 4% in 1H 2024. Whilst applauding the efforts of reining in inflation hitherto, further headways will become progressively more difficult to achieve and the outlook is made even more ominous by the latest EU elections, the rise of popularity of the far right and by the potential re-election of Donald Trump.

The oil balance has been expected to tighten, only it is not. The second half of the year, despite the massively diverging views, is set to experience a significant jump in oil demand, especially gasoline and jet fuel. Between December 2023 and June this year the IEA upgraded its 2H 2024 global oil demand forecast by 500,000 bpd and OPEC, the most bullish of all, by 160,000 bpd. These estimates have not been echoed in the weekly US inventory data; commercial stocks are reluctant to deplete. On the supply side, the OPEC+ producer alliance opted to keep output cuts in place until the end of 2025, apart from the 2.2 mbpd voluntary reductions, which will be gradually unwound starting 4Q this year. The decision goes against the general narrative that oil demand will considerably exceed supply. And lest we forget that even with the rollback of the discretionary production restraints there will still be close to 4 mbpd of oil available in case of unexpected shortages. This, together with the upcoming US presidential election should set a ceiling to any continuous oil price rally.

The current sentiment is one of buoyancy and it is reflected in the recent move higher in a variety of risk assets. Yet, the facts, at least as seen from this chair, are the absence of meaningful supply disruption in the Middle East and Russia, the hesitancy of the Fed to cut rates, the related dollar strength, and comfortable supply cushion. These ingredients strongly imply that notwithstanding current perceptions and acknowledging that a fleeting break over $90/bbl is possible should demand growth really kick in, the performance of 1H is unlikely to be emulated in the second half of the year. To plagiarize John Maynard Keynes: When the facts change, I change my mind – what do you do, sir?

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