Macro: Sandcastle economics
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Crude drops on growth concerns and loss of momentum
Ole Hansen
Head of Commodity Strategy
Summary: Brent crude trades below $80 for the first time since early January as worries about the 2023 economic outlook drives fresh technical selling and long liquidation from traders and investors cutting exposure ahead of yearend. The coming months are likely to remain challenging given an uncertain outlook for both supply and demand, as traders weigh the risk of a recession against a revival in Chinese demand, as well as the impact of continued sanctions against Russia, and not least the risk of another round of OPEC+ intervention to support prices.
Brent continues to lose ground and after closing below $80 on Tuesday for the first time since early January some added follow-through selling took it down to $77.74 earlier today before bouncing. WTI meanwhile touched $72.75, a one-year low, before finding bids. Both futures contracts have come under pressure this past week on fading risk appetite as the attention turns to 2023 and increased worries about an economic slowdown hurting demand. The slump comes against a backdrop of low liquidity with Brent open interest falling to a seven-year low, thereby stoking unwarranted volatility.
The front end of the curve has seen the brunt of the weakness with time spreads weakening to the extent that the difference between the first and the sixth month Brent futures contract, the global benchmark, has returned to a contango for the first time since November 2020. At the peak of uncertainty following the Russian invasion back in March the spot month Brent contract traded 24% above the one year forward contract. By yesterday that premium had shrunk to just 2%, highlighting the extent to which sentiment has changed during the past month.
The Brent crude oil curve has seen a dramatic downward shift during the past month, primarily led by weakness at the front of the curve.
Supply and demand driven refinery margins are good indicators of the given strength of the market and during the past couple of weeks they have increasingly been signalling weakness. Not only in gasoline margins which for months has been seen as an inconvenient by-product for in-demand diesel production, but also diesel margins are now showing signs of cracking following a period of strong demand as European refineries boosted production and demand ahead of sanctions-led supply disruptions from Russia.
The short-term outlook is challenged due to a seasonal slowdown in demand and the negative price momentum feeding additional selling from technical traders and funds closing long positions ahead of yearend. The outlook for 2023, however, remains clouded with traders weighing the risk of a recession against a revival in Chinese demand as well as the impact of continued sanctions against Russia.
In addition, the market must also consider the risk of further OPEC+ intervention to arrest the slide through additional production cuts, while the selling of crude oil from US strategic reserves, which has sent more than 200 million barrels into the market this year, will halt soon. With US commercial crude oil stocks only up 1 million barrels this year and diesel stocks at their lowest seasonal level in eight years, the additional barrels have been shipped abroad as crude and refined products, especially to Europe which in normal times imported more than 50% of its refined products from Russia.
Update from Kim Cramer, our technical analyst.
Brent Crude oil: Following Tuesday’s close below $80.61, Brent has cancelled its bottom and reversal pattern from last week and the bear trend has resumed. Trading in a wide falling channel Brent crude oil has so found support ahead of $77.56, the 0.50 retracement of the entire uptrend since its trough in early 2020. Below, there is no major support until around 65. Weekly RSI is back below 40, thereby supporting the short-term negative outlook.
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