Quarterly Outlook
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Crude oil drops with OECD demand outlook in focus
Ole Hansen
Head of Commodity Strategy
Summary: Crude oil prices trade lower for a second day with traders reducing exposure for fear that a sudden banking crisis started by last week’s collapse of the Silicon Valley Bank will spread to the wider economy and trigger a recession, and with that reduced demand for crude oil and fuel products. So far, however the selling has mostly been driven by speculative long liquidation and not yet a notable change in an otherwise supportive demand outlook, driven by non-OECD countries like China and India.
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Crude oil prices trade lower for a second day with traders reducing exposure for fear that a sudden banking crisis started by last week’s collapse of the Silicon Valley Bank will spread to the wider economy and trigger a recession, and with that reduced demand for crude oil and fuel products. With the US economy currently at the epicentre of these concerns, losses during the past week have been most profound in WTI and RBOB gasoline.
It highlights a widening demand outlook gab between Western nations and Asia, especially China which continues to recover from its extended lockdown period. In their latest oil market report OPEC lower its demand for forecast for OECD countries while raising its demand for non-OECD countries, including China and India. Overall, the group stuck with its call for global demand to rise by 2.3 million barrels a day this year to 101.9 million barrels a day. A projection that is being based on global growth of 2.6% this year, with China’s economy growing by 5.2% while the Eurozone and the US economies will be bumping along at much slower pace of 0.8% and 1.2% respectively.
The IEA which last month forecast a 2023 increase in oil demand of 2 million barrels a day will release its report on Wednesday.
With crude oil demand still expected to grow strongly, the short-term direction will likely be dictated by the general level of risk appetite and the signals being sent from the banking sector as well as yields and interest rate developments.
In addition, the market is also being challenged by long-liquidation from hedge funds who had been almost continuous buyers of Brent crude oil futures since late December. In the week to March 7, the net long reached a 17-month high at 298k lots (298 million barrel), driven by a belief in higher prices but also the curve structure which has remained in backwardation during months of sideways price action.
The backwardated curve structure provides a long investor with a monthly roll yield, currently around 50 cents, while a short position will be penalized by the same amount. It helps explain why the rangebound and calm market conditions up until now has forced a reduction in the gross short to a 12-year low at just 22k lots, thereby raising the long/short ratio to an elevated 14.5 longs per each short. A position mismatch that raises the risk of a correction should the fundamental and/or technical outlook suddenly change.
WTI meanwhile has due to the opposite curve structure, i.e. a prompt contango around 15 cents, seen a lower interest to buy and hold long positions. In the week to February 21, hedge funds held a 164k net long while the long/short ratio was much more benign at just 3.6.
Brent crude oil has traded sideways since late November within a 14-dollar wide range averaging $83 during this time. Despite the combination of an elevated long and the banking fallout loss of risk appetite, the current price is less than four dollars below the mentioned average, and it would take a deeper drop for the overall market sentiment to change. OPEC’s decision to cut production last December looks increasingly wise with a pickup in non-OECD being offset by weak OECD demand. At this point the group is likely to stick to its current production levels as long the price stays above $75 and below $100.
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