Head of Commodity Strategy
Key points
Crude oil continues to trade within a narrowing range, supported by OPEC+ production curbs, and robust summer demand
Investors have enjoyed a strong H1-2024 return, not least due to a beneficial backwardated curve structure
Focus on the demand components in today's US stock report as well as Friday's PCE inflation print
Crude oil continues to trade within a narrowing range, which during the past year has resulted in a succession of lower highs and higher lows. In fact, since Q4-2022 the WTI futures contract has been averaging close to USD 79 per barrel, just a couple of dollars below the current price, and overall it highlights how production restraint by OPEC+ since April last year has helped deliver a period of stable prices, most likely at lower levels than originally anticipated by the group, many of which need prices of Brent, the global benchmark, to trade closer to and preferably above USD 90 per barrel in order to balance their budgets.
From an investor perspective, the crude oil market continues to yield a better return than what the change in the spot price is indicating. While the spot month futures contract in WTI crude trades up around 14% year-to-date, the total return which includes the current positive impact of rolling expiring contracts into the next at a lower price, so-called backwardation (see below for explanation), has reached 19.2%. It highlights the fact that as long as a given market remains relatively tight an investment can still yield a return while the spot price remains range bound.
From a relatively weak start to the year amid concerns about Chinese demand and the negative impact of high funding costs following the most aggressive rate hiking campaign by the US Federal Reserve in decades, the crude oil market has since moved higher with most of the major movements being driven by the ebb and flow of a geopolitical risk premium, and with that the buying and selling from hedge funds looking for momentum. Something they have struggled to find during the past year, and which is reflected through data which recently showed the net long in Brent and WTI briefly falling below 200,000 contracts or 200 million barrels, to a level only seen twice during the past decade. The subsequent bounce has in part been supported by traders re-establishing long positions while closing loss-making short positions.
Later today at 1430 GMT, the Energy Information Administration will as per usual publish their weekly crude and fuel stock report, and while surveys are pointing to an across-the-board stockpile drop, the American Petroleum Institute last night reported increases in both crude and gasoline stocks (see table insert below). We are currently going through the peak demand season, with elevated fuel demand being driven by increased mobility during the vacation season, as well as increased demand for fuel to generate cooling, not least across the Middle East where a country like Saudi Arabia typically sees its summer crude oil burn peak around 700,000 barrels per day.
With that in mind, the focus in today’s EIA report will likely be concentrated on implied demand data for the three major fuels, gasoline, diesel and jet fuel. In the previous week, gasoline demand on a four-week basis reached last summer’s levels, while jet fuel demand rose to near 2019 levels. Apart from this report, traders are also focusing on the dollar ahead of Friday’s key PCE inflation print, multiple geopolitical developments, including the presidential election in Iran this Friday where the choice is between a number of hardliners supported by Iran’s supreme leader Khamenei and Pezeshkian, the only reformist on the ballot paper.
Backwardation and contango explained
Backwardation is a market condition in which the futures or forward price of a commodity is lower than the spot price. In other words, contracts for future delivery are priced lower than the current market price of the commodity. This scenario is often seen in markets where the commodity is in short supply or there is a high demand for immediate delivery. Total return in commodities includes both the spot return (change in the price of the commodity itself) and the roll return (the gain or loss associated with rolling over futures contracts). In a backwardated market, the roll return is typically positive, which can enhance the total return for investors. This contrasts with contango, where the futures price is higher than the spot price, often resulting in a negative roll yield and reducing the total return.
Recent commodity articles:
18 June 2024: Precious metals go through prolonger period of consolidation
17 June 2024: COT: Dollar long jumps; Funds start rebuilding crude long
14 June 2024: Commodity weekly: Energy sector gains counterbalance metal consolidation
13 June 2024: Oil prices steady amid divergent OPEC and IEA demand projections
10 June 2024: COT: Brent long cut to ten-year low; metals left exposed to end of week slump
3 June 2024: COT: Crude length added before OPEC+ meeting; gold and copper see profit-taking
31 May 2024: Commodity weekly: Strong month despite late decline in crude and fuel
27 May 2024: COT: Gold and crude see increased demand as dollar longs plummet
24 May 2024: Commodity weekly: agriculture surges, metals fall on fading rate cut hopes
23 May 2024: Podcast: 2024 is heavy metals
22 May 2024: Crude oil struggles near two-month low
17 May 2024: Commodity weekly: Metals lead broad gains
16 May 2024: Gold and silver rally as soft US data fuels market optimism
15 May 2024: Copper soars to record high, platinum breaks out
14 May 2024: COT: Crude long slump; grain purchases surge
8 May 2024: Fund selling exacerbates softening crude outlook
8 May 2024: Grains see bumpy start to 2024 crop year
6 May 2024: COT: Commodities correction spurs muted selling response
3 May 2024: Commodity weekly: Grains boost, correction in softs and energy
2 May 2024: Copper's momentum-fueled rally halts amid weakening fundamentals
2024: The wasted year
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
