Risk is Turning into Reality
It would be a mild dramatization to conclude that Chinese economic troubles, the latest chapter of which was opened by a Hong Kong court ordering the liquidation of troubled property developer, Evergrande, has been confined to the annals of history but, together with other bearish developments, it certainly did not play a prominent role in the formation of oil prices yesterday. The hasty recovery of North Dakotan oil production, which was down only 5% yesterday, according to the state’s pipeline authority has also gone unnoticed in our market and so have sanguine economic data US data. Climbing US home prices, a rise in job openings and a jump in consumer sentiment all bear witness to a resolute economy and this might give the Fed the perfect excuse to delay rate cuts. After all, why upset the symbiotic, but fragile relationship between high rates and abating inflation? No surprise then that stocks retreated.
Not oil though. Supply issues, actual and feared, were in the crosshair of market players. The Red Sea hostilities are clearly impacting the oil supply. Indian diesel exports to Europe could fall as much as 80% in January from last month, according to tanker trackers quoted by Reuters. Staying on the same page, instead of sending it directly south from the Mediterranean through the Suez Canal, Kazakh oil to Asia is being re-routed around the Cape of Good Hope because of brewing tension in the region. Russia could also be forced to cut naphtha exports due to recent refinery fires. Venezuela braces itself for the re-imposition of US sanctions that might affect its crude oil exports and US President Joe Biden will soon reveal its plan to retaliate to the drone attack that killed US servicemen in Jordan over the weekend, plausibly dragging Iran deeper into the Middle East conflict. The supply side of the oil equation is undoubtedly price supportive in the short term and it was on display in yesterday’s strength in the two crude oil futures contracts. The reversal from Monday’s drop was also aided by the upward revision of the IMF global growth forecast that foresees no recessionary pressure as interest rates remain historically high.
Notwithstanding the API reporting bigger-than-forecast draws in crude oil and distillate inventories overnight the market once again is on the defensive because, yes, you guessed it, Chinese economic data. The country’s manufacturing sector shrank for the fourth successive month although it is worth noting that the composite PMI, which includes manufacturing and services, ascended to its highest level since September. The factory data confirms our view that China, at least for now, is an impediment to global oil demand growth, nonetheless, material supply issues will likely be the dominant force in shaping oil prices in the immediate future.
Inflation Rate YoY Prel (Jan)
ADP Employment Change (Jan)
Fed Interest Rate Decision
Fed Press Conference
Hesitant Money Managers
The latest reports from the CTFC and ICE do not paint an unconditionally upbeat picture amongst financial players in the oil market. The total amount of money under management in the five major oil futures contracts rose during the week ending January 23 but it is still well below what would imply a healthy appetite for risk. Although it climbed by $5 billion week-on-week and is now more than the double of the $17 billion registered mid-December, at $34 billion it still pales in comparison with last year’s peak of $67 billion achieved in September when Brent reached its annual peak of $97/bbl. The message is that unconditional optimism, at least for now, is in short supply, and money managers have not committed themselves to the upside unequivocally.
Last week saw the doubling of net speculative length (NSL) in WTI, possibly due to weather-related production shutdowns, albeit from a historically low level. On the other hand, money managers scaled back on their NSL in Brent. As a result, the European benchmark has ‘only’ 68% of the total speculative crude oil market, down from 84% the week before, which was the second highest level ever since ICE started to publish Brent NSL data in 2011. Given the ongoing geopolitical tension in the Middle East and the protracted war between Ukraine and Russia, Brent will probably remain the instrument of choice for speculators when it comes to pouring money into crude oil, especially if US production normalizes in coming weeks as expected. NSL will likely have increased for the latest reporting week ending January 30 as both WTI and Brent closed higher yesterday than the preceding week implying that confidence has risen somewhat. The long/short ratio of the major crude oil benchmarks are also expected to climb from the current relatively low levels of 1.8 (WTI) and 3.6 (Brent).
Heating Oil and Gasoil have both been equally subdued. Financial investors cut their NSL in the former to under 17,000 lots for the first time since July last year with gross long positions at their lowest since June 2023. Gasoil NSL jumped by 9,000 lots to 19,000 contracts, which is still very low considering that we are in the middle of the winter season. The good news, however, for those with bullish inclination is that gross long positions climbed over 100,000 contracts, the highest since last August. Conflagration surrounding the Red Sea and the wider region together with recent Ukrainian drone attacks on Russian refineries might flip the sentiment on Gasoil, something that is palpable in the increase in the value of the ICE Gasoil/Brent crack spread and the widening backwardation of the contract. RBOB is proving solid with NSL rising to 67,000 lots last week matching historical norms but judging by last week’s price action it is dubious if the optimism could prevail.
It was in the second half of last week that the oil market broke out of its recent trading range to the upside aided by persistent uncertainties around shipping through the Suez Canal and by actual disruptions in Russian product deliveries due to above-mentioned assaults on refiners. This break-out has not shown up in NSL yet but money managers might grow in confidence that prices will remain stable in the foreseeable future and devote more funds to oil. As a rule of thumb rising refining margins are usually the bellwether of tight underlying fundamentals. They started to strengthen on both sides of the Atlantic. Last week the proportion of product NSL in the collective oil mix was still somewhat depressed. The weight of the three product contracts in the basket was slightly under 30%. Climbing above this level will be an indication that investors feel comfortable allocating more money into refined products, an unmistakable sign of growing faith in stronger prices, at least in the medium-term. Until then, any price recovery will be viewed as tentative.
© 2024 PVM Oil Associates Ltd
31 Jan 2024