Markets tend to trade on expectations given their forward-thinking nature and the increasing importance of FOMO. Bets are made when forecasts and predictions are out, and the move is accelerated if the estimates prove accurate further down the line. If not, then sentiment and the trend reverse quickly.

It is this attitude that was visibly absent in the first half of the year. Investors were pragmatic and uncharacteristically careful to commit themselves to the upside notwithstanding the more than sanguine forecasts for the second half of the year. It has been, for months, predicted that global oil demand will grow by leaps and bounds in 2H from 1H of 2023 and this, in tandem with the OPEC+ producer group’s supply management policy should increase demand for OPEC oil and deplete global and OECD oil inventories. The cautious approach was the product of recession worries. It was anything but evident that the protracted rise in borrowing costs would not push major economies into recession.

Then July arrived and the mood has promptly changed. All of the sudden, doubts evaporated, equities kept moving higher and oil finally broke out of its narrow trading range it had moved in between April and June. WTI registered a monthly gain of 15.63% and Brent 13.53%. The true bellwethers were, however, products. The CME RBOB contract jumped 16.58%, whilst Heat and Gasoil returned 22.07/24.06 cents on every dollar invested last month. The 3-2-1 CME crack spread jumped from $97/bbl on July 3 to $126/bbl by last night’s settlement.

The most salient factor in the impressive performance last month is plausibly the action of central banks, both in the monetary arena and in the oil market. To begin with the former conviction is growing that a ‘soft landing’ is achievable and recession avoidable. In the US after 11 hikes in interest rates the Fed could be one more hike away (worst case scenario) from pausing rate rise as inflation slows and the economy proves resilient. Inflation is retreating and the critical Personal Consumption Expenditures index, one of the Fed’s preferred gauges fell back to 4.1% in June, down from 4.6% the preceding month. Despite the continuous rate hikes the US economy powered ahead and grew by a forecast-beating 2.4% in 2Q.

Other top central banks, namely the ECB and the BoE could still opt for another rate increase but neither of them rules out a pause after that. The ECB boss, Christine Lagarde has an open mind on what decision the bank will bring in September, but improving conditions would warrant a halt in rate hikes. The outlook is getting brighter as the growth in consumer prices slows and the region returned to expansion in 2Q. Inflationary environment has improved in the UK and the BoE will also be driven by hard data after possibly upping lending rates this week.

To be clear, brighter inflationary and economic prospects will not provide additional demand supports for oil, but they will halt sowing the seeds of downgrades, quite an achievement, in itself. A layer of uncertainty has been removed for now. The real spark came from the supply side, from the central bank of the oil market. Saudi Arabia, OPEC’s de facto leader, is determined to support oil prices by extending its voluntary 1 mbpd of production cut until the end of the next month but possibly even beyond. It is worth remembering that the Kingdom needs a budget price of above $80/bbl and a sudden reversal would send prices back below this crucial level, something the Kingdom would be loath to see. What is more plausible is that the unilateral decision will be carried over into September and gradually phased out afterwards in case of auspicious price reaction. Belief of depleting stocks in the second half of the year is visibly growing. This supply deficit will be 1.8 mbpd in 2H 2023, according to Goldman Sachs. OPEC, assuming an output level of 28 mbpd in 3Q and 28.9 mbpd in 4Q would go with a stock drawdown of 1.95 mbpd.

These are big numbers, and the market is buying into them. The test of this year’s peaks on the crude oil contracts is becoming ever more probable and the salient question is how long this rally could last. Would forecasts of $100+ and even $140 from last year be dusted off? There are several reasons to believe, or more accurately, suspect, that the upside will be limited and no protracted rally over $90/bbl is feasible. Firstly, the fiercest rival of high prices is high prices. The inflationary pressure of expensive oil, especially gasoline, is well documented and in case retail prices keep rising a.) central banks might be forced to act again and b.) the Biden administration might step in once more to mitigate the negative effect of rising prices with elections fast approaching. Secondly, Russian risk premium registered in the immediate aftermath of the break-out of the war, has all but disappeared. In fact, now that Russian export prices are trading above the G7 price cap it is not beyond speculation that the US and other allied governments will keep quietly whispering words of encouragements to keep trading in Russian oil in order to provide continuous supply ensuring security and prevent prices from hiking. Thirdly, the Chinese economic revival after lifting the Covid restrictions has been found wanting. Just take the latest data. Official factory PMI has been reported below the critical 50 mark, which separates contraction from expansion, for the fourth consecutive month in June. Exports and imports are disappointing, retail sales are sluggish and the property sector, one of the most critical revenue streams of local governments, came to a standstill last year and has not advanced since. China is the engine room of global oil demand growth and lack of improvement will only be overlooked for so long.

The stage, we would argue, is set for further strength, this much is apparent after a spectacular July. However, whether this rally can be maintained on a prolonged basis beyond both 4Q 2023 and $90/bbl is highly questionable in the current geopolitical and economic climate.

Overnight Pricing