Current oil market fundamentals are under pressure, and if you are listening to economists, hedgefunds or Western governments, you may conclude that the sentiment is decidedly bearish. The current low volatility in oil prices is a sign of a potential economic recession. The ongoing debt ceiling debate adds another factor to uncertainty in oil markets, just after the U.S. banking crisis fears dissipated. While bears are currently making a lot of noise, the reality might actually be the opposite. There are indications that a potential bull market is on the horizon, especially when considering the latest oil demand figures presented by the IEA in Paris and OPEC.
Mainstream media reports highlight that the ongoing delays and obstructionism from both U.S. political parties, Democrats and Republicans, in the debt ceiling talks are exerting negative pressure on global oil prices. This has resulted in emotional analysis among oil market players and financial institutions, dampening the growing optimism surrounding expected demand growth in the second half of 2023 and beyond. The market has already priced in lower-than-expected Chinese economic growth figures, and the combination of reduced OPEC production and a slowdown in Canadian oil production is anticipated to support crude prices in the coming months.
The WTI June contract, which is rolling over today, reflects fear. Fear of a possible US economic slowdown, due to a possible default, which could possibly translate into lower demand. However, the markets may be misinterpreting the situation, as a default or full-scale economic crisis is unlikely to be the ultimate outcome of the current power play in the US Senate and Congress. Both parties are aware of the risks involved and the consequences, as evidenced by past experiences. The media's spotlight and the parties' resistance to succumb to pressure in an election year are fueling the push for a dramatic showdown. However, it is widely understood that a new debt ceiling agreement will ultimately be reached, and life will continue as usual. Furthermore, an economic downturn is not expected, as the global economy remains largely positive, and energy prices as well as major commodity prices have declined. The possibility of an economic recession in Europe is not on the horizon either, as European economies demonstrate strength, with a high demand for available workforce even to fill open positions. Outside of the OECD, emerging markets such as the Middle East and India continue to exhibit strength.
Despite this macro-economic outlook, negative sentiment rules the day, as seen by short positions of hedgefunds. As Bloomberg last week reported, hedge funds are ultra-bearish on oil. At present, non-commercial positions are nearing 2011 lows. According to Bloomberg, the majority of money managers are preparing for an imminent recession. The news outlet also reported that hedge funds have expressed extremely bearish views on diesel and gasoil, reflecting levels of pessimism not seen since the early stages of the Covid-19 pandemic. These concerns arise from a combination of factors, including potential interest rate hikes by the Federal Reserve, slower-than-anticipated economic growth in China, and the looming possibility of a US default. Furthermore, hedge funds are concerned that OPEC+ may not fulfill their commitments regarding oil production output.
Interestingly, the physical oil market presents a different picture, as it does not exhibit the same level of bearish sentiment. Demand is expected to rise, evident in increased air travel, robust refinery utilization, and strong demand for gasoline and diesel in the US. Similar signs can also be observed in Europe and other regions. Analysts have cautioned that fuel storage levels, on the whole, are below seasonal norms. Moreover, oil producers and other industry participants have demonstrated a willingness to refrain from hedging against a potential price drop.
In the coming weeks, there is a potential for a significant shift in market sentiment towards a more bullish outlook. The continuous decline in inventories is likely to awaken the majority of market participants. Producers, with their current strategies, may even consider further production cuts if prices drop below $75 per barrel, signaling a strong bullish signal. Additionally, a resolution to the political farce surrounding Washington's debt ceiling, coupled with robust demand during the holiday season worldwide, could further bolster the bullish sentiment.
Underinvestment remains a critical concern, as emphasized by OPEC Secretary-General Haitham Al Ghais. He reiterated that insufficient investment in the oil and gas sector could lead to long-term market volatility and hinder growth. At the Middle East Petroleum and Gas Conference (MEPGC) in Dubai, Al Ghais highlighted the importance of focusing on reducing greenhouse gas emissions rather than simply replacing one energy source with another. Major investments across all energy sectors are urgently needed. OPEC has consistently emphasized the requirement for $12.1 trillion in global investments to meet the long-term rise in oil demand.
The ongoing curtailment of Russian oil production due to Western sanctions poses significant risks to the market. Analysts estimate that 2-2.5 million barrels per day (bpd) of Russian oil production, out of the current 11 million bpd, could be at risk. The latest monthly report from the IEA suggests a potential shortage of 2 million bpd in crude oil supply in the second half of 2023. However, this estimate may already be optimistic considering the statements made by the G7 over the weekend, indicating their intent to strengthen efforts to counter Russia's evasion of price caps on its oil and fuel exports.
As soon as hedgefunds have found their footing again, a major surge back into long positions is to be expected. It takes only one large Wall Street player to turn bullish, and the other sheep will follow.
By Cyril Widdershoven for Oilprice.com