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Alex Kimani

Alex Kimani

Alex Kimani is a veteran finance writer, investor, engineer and researcher for Safehaven.com. 

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Oil Rally Reverses On Signs Of Cooling Demand

  • Signs of cooling demand and rising inventories have resulted in a reversal in crude prices
  • Hedge funds have taken the cue and are beginning to slam the brakes on their oil buying spree
  • Despite the more negative sentiment, a section of Wall Street believes oil prices still have room to run

After a nine-week winning streak, oil prices have gone into reverse gear as worrying signs of cooling demand have begun to appear. WTI climbed 11% and Brent rose 7.5% in the month of October, as global oil consumption outpaced supply and drained stockpiles.

However, another crude buildup in the United States has got the market fretting that this epic rally could be running out of steam.

On Tuesday, the American Petroleum Institute (API) reported an inventory build for crude oil of 3.594 million barrels, more than double the 1.567-million barrels build that analysts had predicted. That marked the sixth straight week of crude inventory build, raising genuine concerns that this bull could be on its last legs.

Hedge funds have taken the cue and are beginning to slam the brakes on their oil buying spree.

The latest Commitment of Traders (COT) report by the U.S. Commodity Futures Trading Commission shows that in the most recent week, hedge funds cut their net long position by 18 million barrels, with reductions in Brent (-18 million) and NYMEX/ ICE WTI (- 7 million), partly offset by additions in U.S. gasoline (+4 million), U.S. diesel (+1 million) and European gas oil (+1 million).

In sharp contrast, funds added 110 million barrels over the previous four-week period.

According to the experts, portfolio managers are still bullish on distillates thanks to their high-gearing to the business cycle as well as potential to benefit from fuel-switching this winter in the northern hemisphere as a result of high gas and coal prices.

They clearly do not have the same faith in crude, and for good reason: Major economic risks as the Fed begins paring back its bond-buying program.

Economic risks

The US Federal Reserve is expected to start "tapering" in a matter of weeks, effectively reducing the amount of US government bonds it buys every month. Right now, the Fed has been purchasing bonds worth $120 billion every month, and the assets on its balance sheet have swollen to nearly $9 trillion.

Although the markets have long anticipated the latest round of taper, investors are still skittish due to stubbornly high inflation and fears that the Fed might be forced to raise rates at a faster-than-expected clip in a bid to tame inflation.

Although the Fed has been talking down high inflation numbers as transitory, persistent supply chain issues suggest the issue is more complex.

Source: Quartz

U.S. consumer prices jumped more than 5% Y/Y in September, a bigger increase than expected. Economic experts like Harvey and Summersare have warned that people and businesses are experiencing even headier inflation than what the CPI is suggesting. For instance, home prices have soared nearly 20%, while some measures of apartment rental prices have jumped by double digits.

The Fed is in a bind, and now has to perform a delicate balancing act. After spending trillions of dollars on stimulus packages designed to support economic recovery, serious supply shortages have emerged everywhere, from housing and microchips to workers as demand outpaces supply. If the Fed hikes interest rates too soon–the main tool for combating inflation—serious wage inequalities can emerge, with incomes for women and minorities bearing the brunt of such overreach in the past. Meanwhile, stagflation–characterized by slowing economic growth and rising inflation–remains a real threat: U.S. GDP expanded a mere 2% in the third quarter after growing 6% in the first half of the year.

Indeed, institutional investors are now betting that inflation could hit 3% in just five years, according to the so-called breakeven rate, which is the difference between the five-year Treasury yield and five-year inflation-indexed securities. That marks the highest forecast of price increases in more than 10 years.

Still bullish

Despite the serious economic overhang, Wall Street remains bullish on the oil price trajectory.

After all, U.S. crude inventories are still 57 million barrels below where they were at the beginning of the year, while bullish trader bets still outnumber bearish ones by quite some distance. Most fund managers have maintained long positions in case prices surge further. It's only that their appetite for adding even more to them appears to have faded for the time being.

Source: Thomson Reuters

A section of Wall Street believes oil prices still have room to run.

Craig Johnson, chief market strategist at Piper Sandler, says the oil price rally still has plenty of room to run.

"We're coming into the winter months and it looks like to me, from looking at an oil chart, we could see oil above the $90 level. It could be closer to $110 to $115," Johnson has told CNBC.

"The energy crunch is still nowhere close to subsiding, so we expect prevailing strength in oil prices in November and December as supply lags demand and as OPEC+ stays on the sidelines," Rystad Energy's Louise Dickson has told Reuters.

Earlier, Goldman Sachs, which had forecast Brent at $90, said the benchmark could even top that by the end of the year.

By Alex Kimani for Oilprice.com

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Leave a comment
  • George Doolittle on November 03 2021 said:
    Demand for natural gas is soaring not demand for oil.
    Demand for coal is soaring as well but distribution costs are too high for the entire World for that unless you are the USA.

    "So natural gas"(both piped and "LNG" or liquified natural gas) it is"

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