Those with bullish propensity are sinking into apathy as the risk premium that is rooted from Russia and the Near East keeps eroding. Ukrainian assaults on Russian oil infrastructure are receding and it appears that the international pressure on Israel not to escalate tension with Iran will mercifully lead to a measured and moderate response to the weekend’s strikes on the Jewish state.

The physical markets are less buoyant than a week ago. The backwardation on both WTI and Brent are narrowing and dated Brent, which for next week was priced more than $2/bbl above the forward market 5 days ago is now fetching a thinning premium of $1/bbl, a rather spectacular retreat. The seemingly supportive weekly EIA stock report could not help either. As refiners cut back on their utilization rates the major product inventories declined whilst crude oil stocks built. Yet, refined products supplied by refiners are stubbornly under 20 mbpd and they insinuate feeble domestic demand. On top of that, the ‘other products’ category registered a weekly rise of 11.2 mbpd taking commercial inventories 10 mbpd above last week’s reading.

Sanguine economic data from the US is likely to lead to delays in the eagerly awaited rate cuts. The latest Fed survey showed expanding economic activity as the IMF predicts that US expansion will be twice as fast as in the rest of the G7 nations. The Nasdaq composite index has shed 5% of its value in the last four trading sessions as inventors heed the Fed’s chair’s warning that it takes ever so long to hit inflation target. The CME FedWatch tool now shows two rate cuts for 2024. There is no doubt that events around the geopolitical/geoeconomic hotspots will provide eventual price supports (the re-imposition of US sanctions on Venezuelan oil exports is helping prices edge higher this morning) and further dips will be viewed as buying opportunities, nonetheless in the absence of actual supply/production issues this market will struggle to convincingly challenge the annual peaks reached at the end of last week.

Non-Existent Structural Bull Market

The price of any commodity or asset class goes up if demand exceeds supply and vice versa. If it lasts for years, it is labelled as super cycle. In fact, the definition of a commodity super cycle is an extended period of boom (and bust) when commodity prices are sustainably above (or below) their long-term trend with these movements outpacing the business cycle in longevity. Commodity super cycles can refer to protracted high or low prices but typically they are associated with structural bull markets, maybe because bear markets tend to have the life span of a mayfly when compared to bull runs.

The precondition of a structural bull market or bullish super cycles is a prolonged period of economic growth, which leads to elevated demand for commodities. The most glaring example of a structural bull market is observed between 2001 and 2008 when the price of Brent rose from $17/bbl to $147/bbl. During this period global oil demand rose by 13%, from 76.2 mbpd to 86.5 mbpd (IEA data). The beginning of the new millennium coincided with China joining the WTO or the circulation of the global economy, if you like, and its thirst for oil jumped from 4.9 mbpd in 2001 to 7.9 mbpd 7 years later, an increase of 61%. By 2008 it was responsible for the lion’s share of global oil demand growth, and it was the sole reason why every man and his dog were unconditionally optimistic on the future and why the intensifying talks of $200/bbl of oil price became deafening in 1H 2008, just before the US sub-prime crisis pushed risk assets over the precipice.

Global oil demand is hitting fresh all-time peaks in 2024 therefore it is only reasonable to ask the question whether we are witnessing the beginning of a new super cycle. After all, there is a growing consensus that the energy transition will take longer than originally hoped for and demand for fossil fuels, including oil and natural gas, will not abate in the foreseeable future notwithstanding ongoing and irreversible efforts to decarbonize the global economy.

Demand, however, is merely one side of the story. For commodity and oil prices to remain above the historical average supply must be lagging and it is something that is not flagrantly obvious. Production and supply from countries outside of OPEC grow at a healthy clip. In the view of the EIA and the IEA it outpaces the increase in oil demand although OPEC takes a strikingly different view. The more salient issue, however, on the supply side of the oil coin is the spare capacity Middle East OPEC producers sit on.

One cannot help but notice that any medium to long-term bull market where demand trumped supply was coupled with low spare capacity, defined as the volume of production that can be brought on within 30 days and maintained for at least 90 days, from the central bank of the oil market. The EIA tracks and updates the supply cushion OPEC might provide in case of unexpected disruptions and the data set is revealing, indeed. At the beginning of the bull market in the early 2000s OPEC’s spare capacity of around 7 mbpd equated to a GDP-deflated WTI real price of $34/bbl (1Q 2002). Towards the end of the bull run, OPEC’s spare capacity dropped to 1.16 mbpd by 3Q 2008 with WTI real price reaching $158/bbl. Then there was a three-year period between 2012 and 2014 when WTI real prices faithfully stayed above $100/bbl with OPEC’s spare capacity reluctantly under 3 mbpd. Re-iterating the central bank metaphor, available supply cushion can be viewed as the interest rate of the oil market – the lower it goes the more it stimulates prices.

Fast forward to the here and now and you will find the available but unpumped barrels from OPEC flirting with the 6 million mark on a daily basis. It is a significant volume that can and most probably will be utilized in case of an emergency or consistently high prices. After all, persistently above average oil will harm the long-term interest of producers as it will re-ignite inflationary pressure leading to renewed tensions with consumer nations. A super cycle in oil can be characterized as a period where satisfying ever-growing consumption is simply not practicable due to supply constraints, however, the current reassuring production cushion makes increasing thirst for the black stuff very much quenchable. The price reaction to a potential supply deficit/demand excess is much more muted when there is something to fall back on.

Overnight Pricing

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