Recent trading range breaks bearish
Weakness in oil markets continues with the price of crude plunging through its recent trading range to its lowest level since November of 2021. Brent crude fell to $72 on Friday, March 17, while WTI fell as low as $62 per barrel. The sell-off commenced last week as fears regarding the stability of the banking system continue weighing on sentiment.
Friday’s sell-off took both WTI and Brent down to their respective 200-week moving averages. The last time the price of crude found itself at this crucial level was back in February 2021, when it broke above it for the first time since early pandemic fears in January 2020 initiated the collapse that would eventually lead to oil futures going negative.
The US Treasury’s announcement that it would step into backstop deposits in Silicon Valley Bank and Signature Bank, as well as the Swiss National Bank announcing a $54 billion lifeline to Credit Suisse, did little to allay worries that the tightening of financial conditions is causing dislocations in the banking system that could lead to broader contagion.
Bearish Sentiment Outweighs Bullish Catalysts
The stimulative effect of China’s reopening and the constraints on supply owing to Russian sanctions and OPEC+ cuts are being outweighed by growing fears of a severe economic downturn due to the global tightening of financial conditions.
In Oct 2022, OPEC+ members agreed to reduce the alliance’s output target by 2 million barrels per day, amid fears of a coming recession in the west and escalating unrest in China due to its zero Covid policy. This was the largest production cut since the beginning of the pandemic. At the time the decision was criticised by the US, fearing that the cuts would force the price of crude oil higher at a time of geopolitical instability.
In hindsight, those cuts appear to have been prudent, and perhaps even not enough. In the wake of the initial decision, it was speculated that OPEC+ may have further cuts to production in store. These failed to materialise and OPEC+ has recently agreed to keep the same production quota throughout 2023. The group’s next policy meeting is scheduled for June, with an advisory panel of key ministers scheduled for April 3.
Oil Demand Expectations Remain High
Despite the bearish sentiment, the fundamentals appear strong for oil. The IEA’s Oil Market Report for March predicted a sharp acceleration of oil demand in 2023, from 710 thousand barrels per day in the first quarter of 2023, to 2.6 million barrels per day in the fourth quarter of 2023. According to the IEA, global oil demand is set to reach a record 102 million barrels per day in 2023. A surge in air traffic and pent-up Chinese demand is expected to be major catalysts for this increased demand.
OPEC’s Oil Market Report for the same month has the group revising up demand from Asia Pacific and non-OECD countries, while OECD Americas and OECD Europe have been revised slightly down. OPEC’s world oil demand forecast for 2023 remains unchanged in March at 2.3 million barrels per day, with OECD demand expected to grow by 0.2 million barrels per day, while non-OECD demand is expected to grow by 2.1 million barrels per day
Potential Bullish Catalysts
A change in strategy on behalf of OPEC could be bullish for oil. Thus far the group has made good on the production cut schedule it set out last year with the cooperation of the larger group of countries known as OPEC+. However, recent comments from OPEC officials have had the effect of curbing the likelihood of further reductions in output.
Last year President Joe Biden laid out a plan for his government to purchase oil to refill the country’s strategic petroleum reserve if prices went down around the $70 level. With oil currently trading below this level, refilling the SPR could provide a boost to demand should the US government make good on its earlier statements.
Any evidence that the US Federal Reserve has successfully guided the US economy in a soft landing, or no-landing, the scenario would be bullish for oil. This would require inflation to continue to moderate without a severe downturn in economic activity or employment.
While the China rebound still appears to be relatively muted in its broader global economic influence, a stronger-than-expected uptick in economic activity in the second half of 2023 is likely to be bullish across the commodity space, particularly crude oil.
In the second half of 2022, the eurozone performed better than expected, allowing the ECB to follow the hawkish path laid out by the Federal Reserve. A continuation of this performance into 2023 is another factor that could provide support to oil markets.
The speed at which global central banks have pivoted from loose to tight monetary policies in their fight against inflation has elevated recessionary fears. The policies are designed to moderate demand, but they are something of a blunt tool that lags in its effects. The fear is that overtightening could cause a cascade of negative shocks to the global economy. The recent failures of regional US banks and the crisis at Credit Suisse have heightened these concerns.
Bank risks weigh heavily on investor sentiment. The memory of the bank failures that preceded the Global Financial Crisis is still fresh in the minds of market participants. Though the recent string of bank failures is due to a different set of underlying conditions, the current fear is that a new banking crisis could severely impact economic growth and thus the demand for commodities like crude oil. During the Great Financial Crisis, WTI crude went from $145 per barrel in 2008, to $33 in 2009.
A brief glance at the recent performance of gold, which has broken out as crude oil prices have been breaking down, reveals a pronounced risk-off turn as a result of all this uncertainty. Gold bulls appear to be challenging the highs set at the depths of the pandemic, and at the start of the Ukraine conflict.
What we’re seeing in the price action is the market attempting to price in the above fears over and above the fundamentals that have IEA and OPEC forecasting growing demand. The next line in the sand is the 200-week moving average. For WTI this level is currently at around $66, for Brent it’s at around $70.
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