Seven-Week Oil Price Rally Ends, But Fundamentals Support Bulls

• China's worsening property crisis has raised serious concerns about the health of the economy in the world's biggest oil importer.
• Commodity analysts at Standard Chartered estimate the August global inventory draw clocked in at 2.8 million barrels per day.
• Saudi Arabia is likely to extend its voluntary 1 million-barrel oil supply cut for the third consecutive month into October amid uncertainty about supplies.

The seven-week old oil price rally triggered by tightening oil markets has suddenly hit the skids after weak economic data coming from China weighed on market sentiment. China's worsening property crisis has raised serious concerns about the health of the economy in the world's biggest oil importer and lowered risk appetite across markets.

Yet, oil consumption figures in China have held up, suggesting those worries might be unwarranted.

"Chinese product inventories are tight and although diesel inventories have recently rebounded from the recent low, gasoline stocks have fallen for 13 consecutive weeks. Demand has been strong enough to keep product inventories subdued even with refinery utilization surging since exiting turnaround season in June,"  RBC Capital's Michael Tran has told MarketWatch.

Likewise, global oil markets remain tight. Commodity analysts at Standard Chartered estimate the August global inventory draw clocked in at 2.8 million barrels per day (mb/d), with a further 2.4 mb/d draw forecast next month. The experts have predicted that inventory tightening will remain the dominant price driver in the coming months, but have warned the markets are still capable of slipping back into the macro-driven angst that we witnessed in the second-quarter for periods. 

Brent crude for October delivery settled at $84.46 per barrel (bbl) on 21 August, a w/w fall of $1.75/bbl after reaching an intra-day low of $83.05/bbl on 17 August. The forward Brent curve has now flattened w/w; however, Brent for delivery five years out rose by $0.51/bbl w/w to $69.26/bbl, a sign that traders remain bullish about the long-term oil price outlook. Related: Money Manager Sees $120 Oil Surprising Bears

Meanwhile, middle distillates prices continue to be driven by supply concerns due to unexpected refinery outages as well as low Atlantic basin inventories. The front-month ICE gasoil-Brent crack remained above $37/bbl on 18 August, the highest level since the end of

January and significantly higher than May’s YTD low of $13/bbl.

All-Time-High Demand Will Push Oil To $100

Global oil supplies have become increasingly tight since late June as Saudi Arabia and Russia cut production. Indeed, the latest energy report by the International Energy Agency (IEA) revealed that global oil demand grew by 3.26 million barrels per day in Q2, reaching an all-time high of 103 mb/d. The IEA estimates that the call on OPEC and inventories will be 30 mb/d in Q3 and 29.8 mb/d, which implies inventory draws of over 2mb/d in both quarters at current OPEC output levels; the IEA assessed OPEC output at 27.86 mb/d in July. The call on OPEC is a measure of the “excess demand” that OPEC countries face, and equals the global oil demand minus both the crude oil production by non-OPEC countries and the production by OPEC countries which are not subject to quota agreements.

Saudi Arabia is likely to extend its voluntary 1 million-barrel oil supply cut for the third consecutive month into October amid uncertainty about supplies, five Wall Street analysts have predicted. The initial cuts appear to have worked, with oil prices climbing about 15% in the past month to about $86 a barrel. 

Commodity analysts at Standard Chartered have buttressed the bullish oil price outlook saying their projections also imply large inventory draws peaking at 2.9 mb/d in August. However, their timing for when demand will hit a new high is a couple of months later than the IEA’s. StanChart estimates that June demand was about 0.5 mb/d below August 2019’s all-time high, but expects the record will be exceeded in the current month. According to the analysts, highly effective producer output restraint, led by Saudi Arabia, will create the conditions for a price rally that will take Brent prices above this year's high at $89.09/bbl onto their Q4-average forecast at $93/bbl, with a likely intra-quarter high above $100/bbl.

Last month, the Energy Information Administration (EIA) forecast total U.S. output will hit 12.61M bbl/day in the current year, eclipsing the previous record of 12.32M bbl/day set in 2019's and easily beating last year's 11.89M bbl/day. U.S. crude oil output is up 9% Y/Y, which under normal circumstances would blunt OPEC’s efforts to keep supplies low in a bid to goose prices. There is little doubt the U.S. Shale Patch is largely responsible for keeping oil markets well supplied and oil prices low: Rystad Energy has estimated that whereas OPEC and its allies have announced cuts amounting to ~6% of 2022's production, non-OPEC supply has made up for two-thirds of those cuts, with the U.S. accounting for half of that. Thankfully, U.S. output is unlikely to go high enough to put significant pressure on international prices.

StanChart says the sharp tightening shown in most H2 balances is starting to spill-over into physical markets, and oil prices appear to be well supported to overcome the negative news coming from China.

Meanwhile, the European gas market remains highly volatile.

Europe is rapidly running out of space to store natural gas, with low demand coupled with plentiful supply allowing the inventory injection season to run well ahead of previous years. According to Gas Infrastructure Europe (GIE) data, EU inventories stood at 106.2 billion cubic meters (bcm) on 20th August, hitting that level 62 days earlier than last year. Gas inventories are now just 3.2 bcm below last year’s maximum; 6.2 bcm below the all-time high and just 10.1 bcm below the GIE estimate of full storage.

Surprisingly, Dutch Title Transfer Facility (TTF) gas prices remain quite high, settling at EUR 36.67 per megawatt hour (MWh). It's going to be interesting to see how the markets will react when Europe’s gas stores are finally full.

By Alex Kimani for Oilprice.com

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