Macro: Sandcastle economics
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Crude oil higher on tightening supply as Iran sanctions bite
Ole Hansen
Head of Commodity Strategy
The battle between fears of a supply-crunch driven by Iran sanctions and a further collapse in Venezuelan production on one side and the future risk to demand as a result of a slowdown in global growth on the other is likely to keep the oil market rangebound for now.
Following some overnight weakness, crude oil is now trading higher ahead of the weekly stock report from the US Energy Information Administration. The main driver has been renewed threats from Iran concerning the Strait of Hormuz and comments from Fatih Birol, Executive Director of The International Energy Agency. Barol said that the combination of strong demand and unstable supply from the Middle East together with falling supply from Venezuela could see the oil market tightening into the year-end period.
Having broken back above $75/barrel, Brent crude oil is aiming to test the upper band of resistance between $78.50 and $80/b.
We maintain the view that in the short-term, the upside should provide the least amount of resistance. Tightening supply has seen the front of the Brent crude oil move back into backwardation and this development is likely to attract renewed demand from long-only funds while the threats by Iran to disrupt the flow of oil through the Strait of Hormuz could increase the geopolitical risk premium.
Continued dollar strength against major emerging market currencies, not least China and India, poses the biggest risk to this assumption. In that case, the market may choose to ignore a challenging supply outlook in the short term given the longer-term risk to demand from slowing growth.
In the week to August 21, just before the 4% rally last week, hedge funds sold crude oil for a third week with the combined Brent and WTI net-long falling by 31,000 to 664,000 lots, an 11-month low. The change was driven by long liquidation in Brent (-16,000) and fresh short selling in WTI (+15,000), the largest one-week rise for 10 months.
Staying on the subject of short-selling, it is interesting to see how limited the interest has been during the past year. Even between July and August when Brent crude oil dropped by almost $10/b, the gross-short (red lines) was kept almost unchanged and close to the lowest seen during the past five years.
With the sentiment once again having turned more bullish due to the increased risks to supply, the net-long is expected to build again. However, the clouded outlook for demand due to trade wars, dollar strength, and EM economies struggling with high debt and rising (dollar) funding costs, is likely to curb the buying enthusiasm relative to what was seen earlier this year.
Staying on the subject of short-selling, it is interesting to see how limited the interest has been during the past year. Even between July and August when Brent crude oil dropped by almost $10/b, the gross-short (red lines) was kept almost unchanged and close to the lowest seen during the past five years.
With the sentiment once again having turned more bullish due to the increased risks to supply, the net-long is expected to build again. However, the clouded outlook for demand due to trade wars, dollar strength, and EM economies struggling with high debt and rising (dollar) funding costs, is likely to curb the buying enthusiasm relative to what was seen earlier this year.
Later today at 14:30 GMT the EIA will release its “Weekly Petroleum Status Report”, providing data on domestic stocks and production levels as well as trade data for crude oil and products. Some temporary price weakness was seen overnight after the American petroleum Institute released its weekly report late yesterday, which showed a surprise albeit small increase in crude oil stocks. Surveys ahead of the EIA report point to a 1.5-million-barrel drop.
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