It wasn’t long ago when the world saw its worst energy supply crisis in decades exacerbated by Russia’s invasion of Ukraine. Yet, since its peak of $140 a barrel in March of 2022, Oil prices have been battered with the majority of resultant price gains forfeited. Weakening global demand stemming from fears of an imminent recession and China’s stringent Zero-COVID policies have resulted in an oversupply. While market angst seemed to settle, with price consolidating between December ’22 to February ’23, the hectic month of March saw the collapse of multiple major US banks and the upheaval of IB Credit Suisse, reigniting turmoil in an already fragile commodities market. Recession fears and slowing demand had compounded with the worsening global oversupply issue - US crude inventories rising 3.3m barrels last week (expected to only be 1.6m) (American Petroleum Institute) and Russian production being excessive considering Western sanctions (International Energy Association). The result was a 20% sell-off in the past 2 weeks as institutions sought to limit their exposure in the options market (option covering), putting in a 15-month low of $64.5 on the 20th of March.

The pivot in Brent crude’s time spreads, declining from $5.26 last week to $2.94 indicate a convergence of WTI futures with the spot price of oil – ie. contango. This reaffirms apprehensions of weakening demand resulting in oversupply.

However, investors have reacted positively to news of Credit Suisse’s acquisition by UBS, backed by the Swiss National bank. Additionally, Oil prices were further buoyed by the Russian energy minister Alexander Novak’s statement that the nation would reduce Oil production by 500,000 barrels per day until June 2023. The WTI is now 3.9% higher than it was at the beginning of the week. Fiona Cincotta, Senior Financial Markets Analyst at City Index says “fears of a banking crisis and a recession have eased, brightening the oil demand outlook at least for now,” However, this may quickly change depending on the market’s reaction to the forthcoming oil inventory reports from the American Petroleum Institute (4:30 pm ET) and the Energy Information Administration.

Indeed, commodity traders are currently facing instability due to the ongoing crisis in the global banking system; however, the situation is not unprecedented. It is reminiscent of the events leading up to 2007 when oil prices had fallen from $77/barrel to $52/barrel in late 2006 when the markets anticipated recession after the Fed raised rates by 450bp. The yield curve inverted, commodity markets were destocked, and spare production capacity was low. However, when the Fed paused and China began to aggressively stimulate its economy, followed by Europe raising rates, the US dollar fell by 12%, and commodity prices almost doubled. The onset of a US recession in early 2008, which is what global markets fear most today, caused commodities to reach record highs as the Fed cut rates and Chinese stimulus led to a surge in demand, causing supply constraints.

While Fed funds futures do indicate an 83 % chance of a 0.25% rate hike to 5% in the Wednesday (Thursday 5 am AEDT) meeting, most economists still believe that the Fed will likely pivot at some point in 2023. The current global macro conditions are increasingly analogous with China exhibiting signs of economic recovery, a continually slowing US economy and soon-to-peak US dollar (MUFG) against a backdrop of tight micro fundamentals – forecasted declining oil inventories from China reopening, return to pre-COVID aviation and Russian output cuts. While it is not likely that economies will experience a repeat of the 2008 GFC due to better preparedness, it cannot be said that commodities will not experience a similar boost when economies cut rates and global demand increases.

As aforementioned, while the 2-week crude free fall has been halted, a reversal will likely require upcoming inventory reports from the API and EIA to be optimistic. Furthermore, eyes will be on the Fed’s announcement for interest rates tomorrow morning. For a bullish pivot, in the mid-long term, macroeconomic factors such as China’s demand for oil during recovery will be vital. Indeed, OPEC forecasts that Chinese oil demand will grow by 710,000 Barrels per day in 2023, a number significantly higher than the projected 590,000 last month. Goldman Sachs’ UK head of commodities believes that Chinese demand coupled with a flight from capital markets will drive oil prices higher.

Going forward, we are bullish on Crude and believe that China’s likely resurgence combined with supply-side reduction will place upward pressure on oil prices. OPEC+ sources believe that the current drop in prices reflects broader market fears for financial contagion rather than supply and demand. We see this in a positive light for commodities going forward as the Fed now faces the dilemma of whether to remain hawkish to prioritise inflation or to take a more dovish approach to ensure financial systems do not collapse. The latter would be more conducive to growing commodity prices.

Barrel Into the Green?

Mar 22 2023