It can cynically be called ‘special military operation’ or a few thousand miles south, perhaps justifiably, the right to defend oneself. The fact of the matter, however, is that wars are raging in Eastern Europe and in the Middle East. Ukraine, it appears, have successfully brought the destruction to the invader and not just to the doorstep but actually into the living room. In the latest round of drone attacks the primary oil refining unit of the Taneco refinery, which is 800 miles from the front line, has been damaged. The Gazprom operated Astrakhan gas processing plant has halted the production of gasoline and diesel, Reuters reported. It is not supply risk anymore that is driving prices but material disruption Russian to refinery operation.

As widely expected, after the weekend’s demolishing of the Iranian consulate in Damascus, Iran has vowed to retaliate. So far, the OPEC member has managed to stay out of the conflict, but in case of a direct confrontation with Israel, the US will, despite its recent warnings to the Jewish state to restrain from attacking civilians in Gaza, provide its unconditional support leading to the widening of the conflict with potentially severe repercussions. The rise in hostilities in both hotspots pushed the price of the two crude oil futures contracts to their highest levels this year with backwardation expanding and products also staged an impressive recovery paying no heed to the sell-off in equities. Bigger-than-forecast draws in US oil stocks reported by the API amplified the move post settlement. Unplanned and unexpected supply concerns, including the sudden cancellation of more than 400,00 bpd of Mexican April crude oil exports, are pushing prices north but whenever these disruptions subside the ensuing sell-off will probably be faster and more vicious than the rise to the summit.
 

Risk was Back in 1Q

A plethora of factors helped risk assets rise in the first quarter of the current year. Promising economic backdrop, apart from China, record oil demand and two wars around major oil producing regions all played their parts in supporting equities and oil on their way higher. Looking back at the ingredients that were the backbone of this rally should help us to draw a picture for the upcoming quarter of the year and establish a view whether the appetite for risk would grow unabated.

The general view is that the global economy, after being devastated by the health crisis and weathering the initial shock of Russia’s invasion of Ukraine is in a relatively healthy state. According to the IMF, the annual worldwide expansion will be 3.1% this year and 3.2% in 2025. Whilst it might be at the lower end of the historic range the fact that recession has been avoided and inflation brought under control is a hopeful achievement in itself.

The US, in particular, stands out. It managed to pull off the seemingly impossible of reining inflation in, accomplishing a soft landing and avoiding a rise in unemployment. Its consumer price index, both headline and core, edged lower between December and February and judging by the latest PCE index it will not increase and could even descend a little bit in March. In the euro zone the rise in consumer prices slowed both in January and February and the ECB, during its March meeting, lowered inflation outlook further. In the UK shop price inflation last month fell to 1.3%, the British Retail Consortium reported yesterday. The bottom line is that the cost of borrowing is widely expected to be cut in the major economic hubs in the foreseeable future. In addition, Japan seems to have successfully left behind the decades-long deflationary era with the only drag on the global economy being Chinese sluggish aggregate demand. Nonetheless, the major stock indices have all posted decent gains in 1Q 2024 although it is intriguing to note that Treasury yields have climbed.

In the previous quarter it became abundantly clear that the reliance on oil would last longer than originally thought and it forced the IEA, the major proponent of peak oil demand, to revise global consumption upwards. Between December and March, the agency upgraded its 2024 oil demand forecast by 400,000 bpd, OPEC added 90,000 bpd to its December estimate and the EIA revised it upwards by the same margin. On the supply side of the oil equation non-OPEC supply and supply growth will be solid but it will not match the increase in global oil demand. Consequently, the call on OPEC will increase year-on-year and the global oil balance is expected to be tighter than in 2023. The conflict between Russia and Ukraine adds another bullish layer to the oil balance as the latter has successfully paralyzed part of the oil infrastructure of the former resulting in significantly reduced product and crude oil exports from Russia. The brewing tension in the Middel East between Israel and Hamas has not entailed supply disruptions yet, but it clearly adds a few dollars of risk premium to prices and the situation could easily escalate.

A tighter oil balance pushed prices higher in the first quarter. Every contract performed reliably with the exception of Heating Oil, which rose by a disappointing 9.8% in the first three months of the year, including rollovers. The rest has returned between 14.7% (Brent) and 17.8% (RBOB). The underlying supply deficit is also embodied in the deepening backwardation of both WTI and Brent. The 3-2-1 CME crack spread finished the quarter some $6/bbl and despite the sometimes wild and wide daily fluctuations it is expected to remain resilient as long as Russian refinery problems persist.

The prevailing mood is aptly echoed in the net speculative lengths (NSL). Money managers have increased their exposure over the January-March period in every contract apart from Heating Oil. Gasoil NSL has quadrupled, collective WTI and Brent net length nearly doubled whilst in RBOB it has increased by 17%. Taking into account the 5 major futures and options contracts asset under management has risen from $30 billion to $55 billion with crude’s share (WTI and Brent combined) increasing from 65% to 74%. Undeniably, 1Q of 2024 was the period of optimism. As for the incumbent quarter the predominant driving forces behind the formation of oil prices will not be the action of central banks, but developments on the supply side of the oil equation – the longevity of Russian refinery outages, Middle East antagonism, OPEC+ output policy and the approach the US administration might take in case domestic retail gasoline prices keep rising ahead of the November presidential elections.

Overnight Pricing

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