Prices of physical crude cargoes have rallied this year, signaling resilient global oil demand even in the face of record-high COVID cases in the Omicron wave. Crude grades from the United States, Africa, the North Sea, the Middle East, and Russia have seen a significant increase in their prices in recent weeks, suggesting that the physical demand for oil is tight across the world.
The tightness in the physical crude prices is reflected in the oil futures market where the backwardation—the state of the market signaling tight supply—has increased for both major benchmarks, Brent and WTI.
The tight physical supply of oil points to further gains in the futures market, where Brent Crude prices hit a fresh seven-year high at over $87.80 a barrel early on Tuesday—the highest price for Brent since October 2014.
Part of the rally in recent days was the result of heightened geopolitical tensions in the Middle East and the Russia-West standoff over Ukraine. But the other major driver was the tight supply on the market, with physical cargo prices rallying, outages in major producing countries, and demand resilient to the Omicron wave. Traders and refiners seem to believe that the feared threat to demand from the new variant was overblown, and are now back to the market buying cargoes much more than they did at the end of November and early December when the impact of Omicron was still a very large looming threat.
Strong Physical Oil Demand
Since the start of the year, prices of crude cargoes that will end up in two or three months in the world’s largest importing region, Asia, have rallied strongly, as refiners are back on the market following some hesitancy at the end of 2021 amid the unknown effects of Omicron on demand. Consumption is resilient, disproving fears of a new dip, and holding up stronger than many analysts and forecasters, including the International Energy Agency, had predicted.
Global oil demand has proven to be more resilient to the effects of the Omicron variant’s spread than the IEA expected, Executive Director Fatih Birol said last week.
“Demand dynamics are stronger than many of the market observers had thought, mainly due to the milder Omicron expectations,” Birol said, as quoted by Bloomberg.
As a result of this resilient demand, refiners are buying cargoes, which raises the prices of physical crude from every part of the world.
“These are crazy numbers. There clearly is physical tightness,” an oil trader in the North Sea region told Reuters this weekend.
The premiums for the Forties and Ekofisk grades from the North Sea are at their highest in two years. The prices of crude grades from West Africa have also jumped amid low Libyan supply in recent weeks. The Bakken crude from North Dakota is also trading at its highest level compared to benchmarks in nearly two years, according to Bloomberg’s estimates.
Price differentials of grades from Russia and the Middle East have also increased to the highest benchmarks in several months.
“(Buyers) are snapping up everything no matter what grade,” an oil trader from the U.S. tells Reuters.
“The physical crude market is way over the forward or futures contracts. It implies genuine prompt tightness,” PVM Oil Associates’ analyst Tamas Varga told Bloomberg last week.
Physical Tightness Reflected In Oil Futures Market
This week, PVM Oil Associates said in a note on Monday that “Positive developments were in focus and there is a genuine belief that physical demand will keep exceeding supply and in return this perceived bullish backdrop will further encourage investors to remain faithful to our market.”
The tight physical market suggests the futures market has further room to rally, traders and analysts say.
“The prompt spreads in WTI and Brent remain elevated at 63 and 74 cents per barrel, thereby signaling rising tightness,” Ole Hansen, Head of Commodity Strategy at Saxo Bank, said on Monday.
“Speculators, a little late to the recent rally, boosted bullish oil bets in WTI and Brent bets by the most in 14 months last week,” Hansen added, noting that the combined net long—the difference between bullish and bearish bets—in Brent and WTI jumped last week by the most since November 2020 to reach 538,000 lots or 538 million barrels. This is still well below the most recent peak at 737,000 lots from last June, he said.
With both the physical and futures markets rallying, and increased geopolitical premium, market observers are again posing the question: how far can this rally go?
According to the world’s largest independent oil trader, Vitol, oil prices—at a seven-year-high early on Tuesday—are justified and have further to go.
Triple-digit oil “is in the works” for the second quarter, Francisco Blanch, head of global commodities at Bank of America, told Bloomberg last week.
Demand is recovering meaningfully, while OPEC+ supply will start leveling off within the next two months, Blanch said, noting that Russian supply will level off and it will be only Saudi Arabia and the United Arab Emirates (UAE) that can produce incremental barrels to add to the market.
Of course, risks to the downside haven’t gone away. The biggest unknown and the largest potential headwind to near-term global demand is China, and whether it would continue to apply its zero-COVID policy, BofA’s Blanch said. Large lockdowns in the world’s top oil importer could reduce consumption and potentially, Chinese oil imports.
Refinery maintenance in the spring could also slow down the physical oil market, analysts say.
Yet, the oil rally may not be over just yet, especially if demand continues to reflect just a “mild Omicron effect.”
By Tsvetana Paraskova for Oilprice.com
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