Oil Weekly: Oil Falls Sharply, Fundamentals Remain Solid

Summary

• The oil price has fallen sharply over the last week and is outside our forecasted range of $75-85 on Brent.
• With fundamentals remaining firm, we see the recent dip in oil below our expected range as an opportunity. We therefore turn from neutral to bullish.
• The biggest winners from the lower oil price are oil importers, airline companies, and consumers.

Oil Hammered Lower        

Oil just had its third-worst week of the year after Brent fell by more than 8% over two trading sessions. We believe the price seems idiosyncratic, currently driven more by positioning than fundamentals.

One reason is that the decline occurred on relatively little news. Second, the decline was more severe than in other cyclical assets, which should have been similarly impacted if the fall was due solely to broader macro fears. Finally, the steep washout in WTI (after hours on Wednesday) was not met with equivalent selling in Brent or oil-based equities.

We expect the Commitment of Traders report out later today to show a sharp decrease in net longs among managed money positions. 

Fundamentals Continue To Improve

Inventories

At the end of March, we reported on the increase in inventories across visible hubs, which acted as a headwind to the crude price. Since then, US inventories in particular have normalised across commercial crude stocks (i.e., excluding the SPR) and refined products – which now sit below the 5-year average at 1,234mn barrels (Chart 2).

We suggested increased refinery maintenance towards the end of last year drove this initial inventory increase. The latest data from the EIA shows the maintenance period is over as utilisation edges higher to c. 90%, resulting in crude inventories falling sharply (Charts 3 and 4).

The refined product picture is more mixed. Gasoline stocks remain dangerously low as we enter US driving season (Chart 5). Distillates inventories look low, though demand should remain weak (Chart 6). Jet Fuel stocks, however, have risen sharply and are now near historic highs (Chart 7).

Refined product stocks in Europe and Singapore also appear to have peaked. Total stocks in Singapore have fallen c. 3.6mn barrels since March to just over 46mn barrels at the end of April. Similarly, Europe ARA data shows total stocks have fallen by c. 1mn barrels during the same period.

Demand

Implied demand for the big three fuel sources looks mixed. In 2022, gasoline demand was weaker than expected due to the sharp rise in prices driven by Russia’s war on Ukraine coupled with a shortage in refining capacity.

The EIA estimates that the price of crude accounts for only 60% of the cost of finished gasoline cost and 50% for finished diesel – the rest made up by refining margins and taxes.

This year, gasoline demand looks to be rebounding, but sluggishly. Demand for distillates remains weak, although that for jet fuel continues to grow steadily (Chart 8).

The main factor ahead will be gasoline demand as we enter driving season. However, given real incomes are now rising on a year-on-year basis in the US, we foresee no surprises.

A strong driving season over the summer should support oil prices.

Supply

OPEC+ cuts come into effect this week, and we should see signs of reduced supply soon. The UAE has already signalled cargoes will be cut by 5% from May, and we expect Saudi Arabia, Kuwait, and Iraq to follow through as well, which should result in global supply falling by 0.8mn b/d.

The Crude Curve

Prompt calendar spreads currently remain backwardated. The WTI near-term spread briefly moved into contango on Wednesday but has since reverted as crude stabilised.

Both the Dubai and Brent contracts remain in backwardation, with the Dubai contract showing relatively little sensitivity to the recent sell-off.

With fundamentals remaining firm, we see the recent dip in oil below our expected range as an opportunity. We therefore turn from neutral to bullish.

Who Wins From a Lower Oil Price?

A lower oil price reflects a transfer of wealth from producers to consumers. As such, an oil price stabilising at c. $70-75 a barrel on Brent would bring about new winners and losers.

We recently argued the biggest losers in EM from an oil price spike would be India, Korea, Thailand, China, and Taiwan. Expect these countries to now benefit the most from a lower oil price. Given India and China are already receiving discounted Urals via Russia, they should benefit less.

Within DM, Japan, Netherlands, Germany, Spain, and the UK are all large net importers of oil and should benefit from an improvement in their terms of trade.

A lower oil price also benefits central bankers, who should see headline inflation fall faster in the coming months. While it may do little for core, the decline will still be welcome. Lower commodity prices have already impacted indicators such as European PPI, Import Prices and more.

Airline companies who still have exposure to the price of jet fuel (via limited hedging) should also benefit, especially over coming months when demand for flights should remain elevated.

Similarly, companies who manufacture paints, coatings, and other chemical-based materials should also benefit as the cost of their feedstock falls. 

And finally, consumer names that have suffered over the last 12 months should benefit as people spend less of their disposable income on food and energy, leaving more room for discretionary purchases.

Viresh Kanabar has worked in the UK financial services industry for over 8 years including in Consulting and Investment Risk. Most recently he launched The Macro Journal Substack where he puts out regular in-depth reports covering all areas of global macro.

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)