There is no doubt that the oil outlook for the months ahead and into 2023 has deteriorated over the past month or so. Europe is probably in recession and the health of its German economic powerhouse is jeopardized by soaring natural gas and electricity prices. The prospect of energy rationing this winter on the continent is very real. At the same time, high retail fuel prices are beginning to dampen oil demand growth, as suggested by preliminary U.S. gasoline sales over the recent Independence Day weekend. . The supply picture has brightened up a bit; Russian oil production is falling less than expected, and Washington has signaled that it is not interested in lowering it.
This alone would warrant a price correction; but the economic downturn should prove much more pronounced to push Brent below $80-90 a barrel on a sustainable basis, not to mention the $65 price suggested by some banks. There is always a strong gravitational pull at the round number $100.
Oil was one of the biggest gainers of the first half for many investors, and some cashed in early in the second half, using commodity profits to cover losses in the stock and bond markets.
For now, at least, the physical market remains solid. OPEC+ has increased production to near its limit, with only Saudi Arabia and the United Arab Emirates in a position to increase production further. At the same time, Chinese oil demand is recovering rapidly from April-May shutdowns. Shanghai’s roads are once again congested. If the physical oil market is not tighter, it is because Washington is selling huge quantities of crude from its strategic oil reserves, which is capping prices. At around one million barrels per day, sales exceed production in some OPEC countries. But these versions will end in October or they will be reduced in size.
Russia can arm its oil exports – or those of neighboring Kazakhstan – at any time, reducing supply to a starving global energy market. Oil investors seem oblivious to the machinations in Moscow, just as the gas market was in April, May and early June. At the time, European natural gas futures were even dipping below 100 euros ($101) per megawatt hour, and some were talking about oversupply. Since then, Russia has sharply reduced its gas exports to Germany, Austria, Italy and several other countries in Europe. On Tuesday, gas prices in Europe jumped to 175 euros. To assume that Russia will not use its oil exports for economic warfare is to ignore everything that has happened so far this year in the energy market.
While oil derivatives markets sold off on Tuesday, physical crude markets held up quite well. North Sea, Mediterranean and West African varieties of crude oil are selling at record, or near-record, premiums to the Brent oil benchmark. In another example of strength, Saudi Aramco has set the official selling price of its flagship Arab Light in northwest Europe at a record premium to Brent. For Asia, its largest market, it was set at the second highest level on record.
Despite the massive sell-off, time spreads on oil remain very strong. Nearby oil contracts continue to trade at a significant premium to contracts for later delivery. The downward slope of the curve, known as the offset, is a feature of a very tight physical oil market. At around $4 a barrel, the first-to-second month runoff is near its strongest on record. In July 2008, oil time spreads were in the opposite situation: a contango, with spot barrels at a discount to futures, a sign of an oversupplied market.
So why did oil prices fall so much on Tuesday? The liquidity of futures contracts in the oil market is very low, which makes them vulnerable to anyone unwinding a large position or selling futures contracts. Both happened this week. Over the summer, several big hedging deals with growers are likely, including the annual deal used by the Mexican government to lock in prices for the following year. On Tuesday, oil traders reported that Wall Street banks were buying big 2023 put options — likely a sign that a big client was in the market to hedge oil prices. Don’t confuse the one-day price drop with a harbinger of the release of pressure that has driven Brent prices up more than 50% over the past year.
More from Bloomberg Opinion:
Biden needs more than Saudi oil: editorial
OPEC+ has done its job, but don’t expect it to go away: Julian Lee
• The United States is depleting its strategic oil reserve faster than it seems: Javier Blas
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Javier Blas is a Bloomberg Opinion columnist covering energy and commodities. A former Bloomberg News reporter and commodities editor at the Financial Times, he is co-author of “The World for Sale: Money, Power and the Traders Who Barter the Earth’s Resources.”
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