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Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Crude oil focus on stocks, sanctions, and Florence
Ole Hansen
Head of Commodity Strategy
Brent crude oil has once again moved to within striking distance of the key area of resistance around $80/barrel. The bounce last week before even testing support at $75/b indicates how traders remain more concerned about the short-term outlook for supply than a potential future risk to demand from slowing emerging market growth.
This was also highlighted in recent weeks by the changed behaviour among leveraged funds. After cutting their combined bullish oil bets in Brent and WTI from a record 1.1 billion barrels to 666 million between February and August, they picked up 137 million barrels during the past couple of weeks. In its Monthly Oil Market Report for September, meanwhile, Opec highlighted the potential future risk to demand when saying that trade tensions, monetary tightening by central banks, and the financial problems of some emerging nations “constitute challenges to the current global economic growth trend.”
While not yet showing up in the official demand growth forecast for 2019, the cartel nevertheless said that “it will be essential to monitor the uncertainty in currency and financial markets.”
This was also highlighted in recent weeks by the changed behaviour among leveraged funds. After cutting their combined bullish oil bets in Brent and WTI from a record 1.1 billion barrels to 666 million between February and August, they picked up 137 million barrels during the past couple of weeks. In its Monthly Oil Market Report for September, meanwhile, Opec highlighted the potential future risk to demand when saying that trade tensions, monetary tightening by central banks, and the financial problems of some emerging nations “constitute challenges to the current global economic growth trend.”
While not yet showing up in the official demand growth forecast for 2019, the cartel nevertheless said that “it will be essential to monitor the uncertainty in currency and financial markets.”
The main driver of these supply concerns remains the US sanctions against Iran which have already started to have an impact on Tehran's ability to sell its crude abroad. This is forcing the return of floating storage with Bloomberg reporting that at least five Very Large Crude Carriers (VLCC) have anchored off the Iranian coast in the past couple of weeks.
Together with Russia, Opec producers with spare capacity are unlikely to make up the shortfall from Iran. This development is driven by the current divergence in the shape of the WTI and Brent crude oil curves. While Brent has seen the front end of the curve flip from contango to backwardation (from loose to tight supply) during the past month, WTI has only managed a general shift higher as the prompt price rallied.
This development has helped trigger a jump in Brent’s premium over WTI to $10/b.
Also driving the change has been the ongoing problems with bottlenecks within the US – something that has become increasingly painful for producers from the Permian shale region in Texas. Lack of pipeline takeaway capacity has triggered a deep discount between Permian oil and WTI crude oil. As a result, we are beginning to see production growth slowing, something that led the Energy Information Administration in its latest Short Term Energy Outlook to cut US production growth both in 2018 and 2019.
Apart from the EIA’s weekly update on stocks, production, and trade at 14:30 GMT, the market is also keeping a close eye on Hurricane Florence which is expected to slam into North Carolina this weekend. Potentially at risk is a disruption of the Caledonian pipeline, the main artery transporting fuel from the Gulf of Mexico refineries to the metropolitan East Coast. Any disruption could trigger a jump in gasoline and diesel futures given the risk to supplies into New York Harbour, the physical delivery point for RBOB and ULSD futures.
Later today, as mentioned, the attention turns to the Weekly Petroleum Status Report from the EIA. Last night the American petroleum Institute reported a price-supportive 8.6 million barrel draw in crude stocks, somewhat higher than a Bloomberg survey pointing to a two million barrel drop.
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