Something odd is happening in the oil market. Despite news that Saudi Arabia would extend its voluntary production cuts for another month and possibly beyond, and despite Russia saying it would reduce exports by half a million barrels daily, prices are falling.
Traders are selling their oil positions instead of boosting them in anticipation of the supply crunch. Logically, this is what follows a production cut, especially one of 1.5 million barrels daily. Yet there is no less logic in seeking to anticipate weaker oil demand in case of a global slowdown, which traders appear to be doing.
The Wall Street Journal reported this week that the Brent futures market had swung into a contango, meaning that spot prices for the benchmark crude had fallen below the futures price. What this suggests is that traders don’t really expect a supply squeeze anytime soon.
The latest factory data, as reported by Reuters earlier this week, revealed that factory activity had slumped across regions, notably in much of Asia and the eurozone, as well as in the UK. Activity increased in China, but the increase was, it seems, too small to impress oil traders.
Combined with central banks’ continued focus on rate hiking as a cure for inflation, the economic growth outlook for some of the biggest oil markets in the world is not looking good, and trader behavior confirms it.
Reuters’ John Kemp said in his latest column on oil trading that sentiment among institutional traders had not been so bad since 2020 when governments’ pandemic response wrecked oil prices as lockdowns destroyed demand.
The net position of institutional traders across the three most traded crude oil contracts—Brent, NYSE WTI and ICE WTI—had fallen to 205 million barrels at the end of June. This was the lowest since records began in 2013, Kemp noted. Related: Iran’s Growing Oil Production: A New Threat To OPEC’s Market Grip
It seems that despite conflicting forecasts on oil demand in the second half of the year, traders have picked the pessimistic road. OPEC and even the International Energy Agency, as well as most investment banks, expect a rebound in demand. Yet the World Bank warned last month that global growth would slow down during that same second half, dragged down by inflation and the response of central banks to it.
Interestingly enough, the World Bank forecast is not all that pessimistic. It actually revised upwards its outlook for the global economy in its latest update. Yet demand pessimism appears to have become a fixture of oil markets lately, keeping prices lower despite production cut commitments.
Things could yet turn around later this year. Despite the eurozone’s recession, China’s slower-than-expected recovery, and doubts about U.S. growth, the world continues running on oil. Sooner or later, output cuts would begin to affect prices. Unless the demand outlook gets even grimmer than it appears to be now, based on oil trader behavior.
If demand proved to be resilient in the face of economic slowdown challenges, however, prices could reverse course swiftly and sharply. Reuters’ Kemp wrote that “extreme pessimism towards crude prices and lopsided positions are creating potential for an explosive rally in future.”
Meanwhile, the head of commodities research at ING noted that “Fundamentals are not having as much influence on price direction as one would expect. Instead, the uncertain macro outlook is what the market is focused on.”
This basically means that traders do not even care about actual demand right now. What they care about is the direction demand would take in the immediate future based on things like factory activity and consumer spending. And this may blindside them in case China, for example, picks up the pace of recovery or the Fed ends its rate hikes ahead of schedule.
By Irina Slav for Oilprice.com
- Oil Prices Inch Higher In Cautious Response To Saudi And Russian Cuts
- IEA Warns Of A Spike In Energy Prices This Winter
- Trans Mountain Pipeline Unlikely To Ship Canadian Oil To Asia