In an indication of a lack of assuredness from the oil complex, the five main futures contracts registered week-on-week changes from 13/10/2023 to 20/10/2023 as follows: WTI +$1.06/barrel, Brent +$1.27/barrel, RBOB +7.66c/gal, Gasoil +$5.75/Mt and in a surprise from what should be the leader of the seasonal pack, Heating Oil posted a loss of 5.51c/gal. 

These historical marks do little in representing the very flighty moves experienced across the board and in fact neither does listing the ranges. Using the same weekly date period the high/low range for WTI was $7.43, Brent $4.91, Heating Oil 21.15c/gal, RBOB 22.15c/gal and Gasoil $54.75/Mt. This is probably more representative of the fickle nature of movement and how rallies lacked the will to follow through, but this unease of position holding has not stopped the market making sure it is covered to any further higher spikes, which is represented by the commitment of traders (COT) reports on ICE. Money managers have increased their bullish Brent crude oil length by 74,288 net-long positions to 227,462, long-only positions rose 45,089 lots to 253,604 in the week ending Oct. 17 and the most bullish in three weeks.
 

Markets thrive on confidence, on trends, on predictability of asset relationship. These are very much lacking at present and the troubling factors within markets run very much akin to how the FED views stability at present. The predominance of inflation and the interest rates arrayed against it, the lack of economic progress in China, apart from Japan the quantitative tightening in many economies and the bond to yield relationship. This is then all topped off by the never ending conceptual flow charts of what might just be inspired by the Israel/Gaza conflict.
Monday mornings are there for study, for contemplation and sober decisions. What is occurring in the Eastern Mediterranean draws scales across the eyes of those seeking to find investment pathways. Oil traders and oil investors will have to default long, how can they not? The tinderbox of Palestine/Israel is once again threatened with a new spark and while its overall economic influence is so much less than the Ukraine invasion, it is nonetheless more emotional and dogged with religious and historical indoctrination that is beyond logical analysis and why our market will continue to run scared of the next headline, and the one after that, and the one after that. Below, Tamas expands on this unpredictability.

History Will Teach Us Nothing

History apparently repeats itself, or at least, as Mark Twain put it, it rhymes. If true, then a helping hand is provided from the past when the unexpected is thrown at us. All one needs to do is to look back at the consequences of that particular event and apply the outcome to the present day. The slight trouble currently is that we are living in unprecedented and disturbing times and the tension, the scope of wars, military, political or economic, are incomparable with past affairs because they have never happened simultaneously. The future, the repercussions of developments therefore are unpredictable, and uncertainty lingers over everyday lives and, as a result, over markets. As for the latter, what we have been seeing lately is nothing but compulsive headline trading as the future, even the near one, cannot be foreseen with confidence. A great example of this well-justified approach is volatility. A certain sense of calmness was palpable in our markets over the summer, but this relatively serene period came to an abrupt halt two weeks ago. Brent volatility increased from 15% at the beginning of September to over 40%. Investors are nervous and the number of “known unknowns” keeps climbing.

In this unsettled environment any prediction amounts to nothing more than tossing a coin really. What is, however, intriguing to observe is the relationship between different asset classes, namely the diverging sentiment that surrounds equities and oil. To put it bluntly, oil is relatively expensive. Of course, in absolute terms the debate is wide open whether Brent at $93/bbl is cheap or expensive, nonetheless it has been much more resilient than stock markets. The MSCI All-Country Index lost 2.5% of its value last week whilst Brent advanced 1.4%. When we zoom out and look at the medium-term picture the tendency is the same. The stock index/oil ratio (dividing the index value by the Brent price, that is) has been narrowing implying comparative strength of oil over equities. The current value of this ratio is 7 – one unit of stock index would buy you seven barrels of Brent. The 2020-to-date average based on weekly settlement prices is 9.5 and at the end of June equities were nine times as costly as oil.
The explanation for the narrowing of this ratio of late is prosaic. The geopolitical hotspots and economic developments are having an actual and/or perceived adverse impact on global oil supply and at the same time they considerably hinder economic growth and meaningfully restrict the fight against inflation. When looking at the individual events separately, a view, however unreliable, can be formed whether this trend is likely to reverse or hasten. These major events, in our view, are the re-emergence of the Israel/Palestine hostility, Russia’s war against Ukraine, the US/China trade war and, for the short-term, the charade in the US legislature.
 

Middle East: It is akin to a barrel of gunpowder; it could explode any time. It is the archetypal case of both parties being the victims and the perpetrators at the same time. After the horrific attack of Hamas on Israeli civilians two weeks ago the Jewish State is responding in kind. A ground offensive in Gaza will almost definitely take place, consequently tension will escalate. The pivotal question is whether it will become a regional conflict where the Israeli-Arab opposition, or even inter-Muslim malevolence will lead to a significant supply disruption. A quick glance at the map reveals that there are several oil producing countries in the region, namely Bahrain, Iraq, Iran, Kuwait, Oman, Saudi Arabia and the UAE. Their combined output is just under 24 mbpd and an all-out conflict will inevitably have an impact on production or shipping in case the Strait of Hormuz comes under blockade. Escalating wrath in the region will strengthen economic headwinds, potentially rising oil prices will push global inflation higher, monetary tightening could resume, and global oil demand growth will be dented.
 

Russia’s war: The main culprit behind the entrenched inflationary pressure is Russia’s invasion of Ukraine. Not only did it drive energy prices higher but also led to elevated price levels in other raw materials and agricultural products causing an unbearable economic pain in several developing nations and sending consumer prices to multi-decade highs in the developed part of the world. A peaceful resolution of the war will go a long way to provide a solid economic backdrop, not just for Russia’s adversaries but for the invader itself. Is it plausible? The Russian parliament passed a law last week whereby it revokes the ratification of the Comprehensive Nuclear Test Ban Treaty increasing the odds of nuclear testing leading to an arm race which other nuclear nations, China, India and Pakistan might join. So, the answer is no. The situation in Eastern Europe will get worse before it gets better. The timing of the bill is no coincidence. Because of the Middle East crisis, a Ukrainian fatigue has set in, hopefully temporarily, presenting a window of opportunity to Putin to up the ante.
 

The US-China relation: whilst the global oil balance in the trade war between the world’s two biggest economies is not directly affected reciprocal trade sanctions hinder economic prosperity. The unspoken view is that the mutual bans imposed on goods and services of the two countries do have a harmful impact on economic prospects. China’s 3Q GDP growth of 4.9% was sold as a success story but when compared with the pre-Trump expansion of 8%-10% the competition for dominance is clearly disadvantageous. The same goes for the US. In an ideal trade environment (ie. in the complete absence of trade barriers, the instigator of which, in the name of national security, was the US as its manufacturing sector started to decline in the past decade) reining in inflationary pressure would be much more straightforward than it is now. The ongoing tragicomedy in the Republican-dominated lower chamber of the US Congress might shortly even exacerbate the situation because without a House Speaker the government might be forced to shut down next month sending equities lower and yields higher.
 

The outlook is ominous. Oil is holding up resolutely because two of the current world affairs are taking place in producing regions and due to the Saudi determination of keeping their own production constrained. The spread or the difference between equities and oil is likely to remain depressed for now and the ratio has been and will be viewed as a reliable benchmark of investor sentiment.

 

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