Head of Commodity Strategy
Summary: Crude oil trades near unchanged on the month after spending most of that time recovering from an early January selloff. In the short-term resistance in the $90 area in Brent is likely to remain firm with recession risks offsetting an expected rebound in Chinese demand and supply concerns related to the February 5 introduction of an EU embargo on Russian seaborne sales of fuel products. We maintain a patient but bullish outlook for crude oil driven by strength in the product market.
Crude oil trades near unchanged on the month after spending most of that time recovering from an early January selloff that was driven by IMFs global recession warning. While that risk remains and, in some places, have strengthened, the market has managed to find support from an expected increase in Chinese demand and supply concerns related to the February 5 introduction of an EU of an embargo on Russian seaborne sales of fuel products.
Developments that together with a temporary disruption in the US following the late December winter storm, and low inventories of middle distillates such as diesel, have seen the bounce across the energy sector being led by the fuel sector where diesel and gasoline futures trade up between 2% and 5.3%.
Once the EU embargo on Russian seaborne fuel exports kicks in we are likely to see prices for gasoline and especially diesel remain supported by tightening supply. Russia may struggle to offload its diesel to other buyers with key customers in Asia being more interested in feeding their refineries with heavily discounted Russian crude, which can then be turned into fuel products selling at the prevailing global market price.
Supply of diesel to Europe from the US and the emerging refinery hub in the Middle East, may make up some of the missing barrels from Russia, but a shortfall seems likely, not least considering the prospect for a strong recovery in China leading to lower export quotas. In addition, the recovery in jet fuel demand will likely pressure diesel yields, thereby creating another layer of support for distillate cracks on either side of the Atlantic.
The result of these developments being rising cost of fuel products as highlighted in the chart above. While the price of crude oil matters to the producers and oil refiners, the consumer is mostly concerned about the cost of refined products from gasoline, diesel, heating oil and jet fuel. Last summer’s surge in crude oil was felt extra hard by consumers as refinery margins spiked higher, at one point driving the NY Ultra-light Sulphur diesel futures contract above $200 per barrel of crude equivalent.
In Europe, the gas oil distillate futures contract, which is used as the benchmark for pricing diesel, jet fuel and heating oil traded throughout the second half at a premium of more than 30 dollars to Brent, versus a long-term average closer to 12 dollars. Adding to the tightness over the coming months is the prospect of a very busy maintenance season, delayed from last year when refineries kept going in order to cash in on the mentioned record margins.
Other developments in the energy market have been a renewed widening of the WTI discount to Brent, currently around $6 per barrel. One of the main drivers being the late December cold blast, which caused refinery outages and a drop in demand of more than 1 million barrels per day. In addition, exports also suffered a temporary slowdown, and the combination of these two saw domestic crude inventories jump 27.4 million barrels during the past three weeks, and with Cushing, the delivery hub for WTI crude oil futures, seeing a 10.4 million barrel jump to a December 2021 high, the price of WTI has suffered accordingly due to rising availability of supply.
Further upside for crude oil is likely to prove difficult until more supporting demand news emerges, especially related to the expected post-LNY activity pickup in China. While the three-month spread in WTI, currently between the March and the June contract trades in contango territory at -37 cents/barrel, the corresponding spread in Brent has risen to a 57 cents/barrel backwardation, a sign the market is pricing in tightening supply and demand outlook.
Brent is currently trading within nine-dollar wide up trending channel within a medium-term downtrend, both offering firm resistance in the $89-$90 area. A breakthrough, which we view as unlikely in the very short term, is likely to send the market higher towards the 200-day moving average, currently at $97.50. Ahead of channel support at $80.35 some support is likely to be provided by the 21- and 50-day moving averages, currently around $83.50.
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Head of Commodity Strategy
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