Both equities and oil were back in demand last week. As a matter of fact, the latter registered the second successive weekly gain whilst stocks, despite a blip on Thursday and Friday, largely driven by the tech sector, kept marching higher. It appears that this general optimism is based on expectations, rather than facts. It implies that risk assets are prone to retracement without changing the underlying sentiment or outlook.

Last week was central bank heavy. Amongst developed nations the Swiss National Bank, Norway’s central bank and the Bank of England all decided on the costs of borrowing. The SNB cut rates for the second time this year. The view from the Alpen country is that inflationary pressure is subsiding, and economic activity will improve due to stronger demand from abroad. Norges Bank has taken a somewhat different approach by leaving borrowing costs untouched and emphasizing no impending cuts this year because the county’s economy has not cooled as fast as anticipated earlier. The Bank of England also refused to lower interest rates, however, headline inflation in May hit the target level of 2%, consequently a retreat from the 16-year high of 5.25% in August is now more realistic than just daydreaming. 

Earlier this month both the ECB and the Bank of Canada reduced the price of money with the Australian central bank opting to be a little bit more patient. Which leads us to the mother of all central banks, the Fed. As expected, there was no change of guards at the June 12 meeting, but cooling labour market and sluggish retail sales might just warrant the first rate cut in September, the very last opportunity to have an impact on the outcome of the November presidential elections. Considering the sporadic, but tangible relationship between oil and the dollar it is imperative that the US quickly follows in the footsteps of the central bankers of the ECB, the SNB and the BoC, otherwise the greenback will remain expensive relative to its peer acting as a brake on further oil price strength. It would also have an adverse impact on the economies of developing nations that have a huge amount of debt that needs to be serviced in dollars. To cut a long story short, perceived cheapening of interest rates in several countries kept investors’ mood buoyant last week. The MSCI All-Country Index gained 0.52% last week. The Nasdaq Composite Index, fueled by Nvidia, which briefly became the world’s most valuable company, reached fresh record highs but please make a note of the dollar strength as its index also ended the week on a high note.

These perceptions are called geopolitics and demand excess in the oil market. No actual supply disruptions are expected in the Middle East now, but the belligerent rhetoric goes a long way to provide support for the black stuff. The leader of the Lebanese militant group, Hezbollah, warned Israel of a fight with ‘no rules and no red lines’ in case of an escalating conflict and also fired a shot across the bows of Cyprus underlining the consequences of taking part in the conflict by supporting the Jewish state. Ukraine has done more than rattling its sabre as it renewed its effective drone strikes against Russian oil infrastructure, another factor in last week’s positive performance.

The chief underlying reason behind the price strength, nonetheless, is the growing confidence that global oil inventories will inevitably plunge during the summer in the northern hemisphere. You will not be surprised that estimates greatly diverge, yet the view of declining stocks is becoming ever so prevalent. Energy Intelligence sees stocks depleting by more than 2 mbpd throughout October. According to Citi, the 3Q oil balance shows a global crude oil and product deficit of 200,000 bpd, the same figure from Goldman Sachs is 1.6 mbpd. Dusting off the latest set of data from the EIA, the IEA and OPEC serves as a reminder that in the third quarter of the year demand should exceed supply, in the above order, by 560,000 bpd, 700,000 bpd or 2 mbpd.

The oil balance pendulum swings widely but tightness is penciled in. (The 4Q outlook is somewhat fluid given that the OPEC+ group is meant to start the unwinding of its voluntary 2.2 mbpd output cuts in October.) It is reflected in the confidently widening crude oil backwardation. The August/September WTI spread widened from 50 cents/bbl to 77 cents/bbl last week. Brent trumped this feat by widening to 91 cents/bbl. The physical European benchmark, which was priced 35 cents/bbl over the September forward contract for 1-5 July a week ago, commanded a premium of $1.13/bbl last Friday.

Expectations, perceptions and the fear of missing the gravy train can be and are powerful price drivers. Some caution on unlimited and immediate further upside potential is warranted, however. Firstly, distillate crack spreads are reluctant to shine unreservedly. They remain rather subdued and fail to reflect the optimism seen in the widening crude oil backwardation. Friday’s jump in the RBOB crack, on the other hand, is promising. Secondly, despite the drawdowns in US oil inventories across the board, total commercial stocks in the biggest demand center of the world remain above last year’s level and are on par with the 5-year average. As the weekly Petroleum Status Report is a faithful forerunner of the potential changes in OECD stocks, palpable decline in US oil stockpiles would boost the current confidence further. The market has done well in June, it put its money where its mouth is, now perceptions must be backed up by decisively rising demand for products, not just crude. On the financial side, the weakening of the USD, which might only happen if the Fed sends out its strongest signal yet that rate cuts are imminent, would also bolster the underlying constructive sentiment.

Overnight Pricing

© 2024 PVM Oil Associates Ltd