Extreme, But Unjustified, Pessimism Has Returned to Oil Markets

Oil prices have pulled back sharply in the month of May with prices posting their steepest weekly loss in three months. The front-month contract plunged to an eight-week low of $82.41 per barrel in intra-day in early trading on 7 May, good for a $5.07/bbl w/w decline while Brent for July delivery fell by $3.87/bbl w/w to a settlement of $83.33/bbl. 

The oil price selloff appears to have been triggered by a return of demand pessimism thanks to last week’s report by the EIA that showed a 7.3M-barrel build in U.S. crude stocks, the largest weekly increase since February, as well as the recent revelation by the United Arab Emirates saying it had raised production capacity.

When the UAE “brings 200,000 barrels extra to the table, that raises their baseline,” Mizuho’s Robert Yawger has told Dow Jones. “It’s no coincidence they pushed that number out there a month before the meeting.“Commodity analysts at Standard Chartered have argued that these demand fears are overblown, especially considering that oil prices are trading below the levels that most OPEC ministers would consider indicative of a balanced market, meaning we are likely to see a rollover of OPEC+ production cuts for at least another month.

StanChart says that traders are betting that OPEC+ will maintain the current levels of production restraint due to deteriorating fundamentals rather than a proactive decision to tighten balances. However, the analysts have pointed out that the current set of oil balance forecasts from the main agencies would not seem to support the extreme pessimism.

StanChart claims to have conducted a highly unscientific straw poll of traders that has revealed very little consistency between these concerns. Some traders are bearish due to a growing number of potentially negative economic outcomes; others believe the Middle East conflict will end up being bearish for oil, while others think that current supply-and-demand market data is concealing significant surpluses.

The commodity experts, however, have conceded that weak U.S. transportation fuel demand appears to be a more prominent thread. Last week, The EIA estimated that U.S. gasoline demand declined 4.4% Y/Y in April, triggering a rapid pivot by speculative funds towards the short side of the market. However, StanChart has pointed out that there appears to be a systemic downwards bias in estimates of U.S. fuel demand, with actual gasoline demand exceeding estimates in 22 of the past 24 months, while distillate demand (mainly diesel) has been revised higher in all of the past 24 months. StanChart believes the latest EIA estimate for April gasoline demand is too low with actual demand likely to surprise to the upside.

Room For OPEC Cuts

Standard Chartered has also speculated that traders could be worried that OPEC+ has very limited scope for any cuts at the moment, and that any additional production such as UAE’s as well as schedules for payback of past over-target output volunteered by Iraq and Kazakhstan could end up upsetting the market balance. StanChart has, however, previously argued that OPEC+ has room to increase output by over 1 mb/d in Q3 without increasing global inventories, meaning global markets could still be in a position to absorb the UAE’s production increase of 200,000 barrels per day.

StanChart’s machine-learning oil price model known as SCORPIO indicates that the downdraft in oil prices could drag on, with Brent prices falling $1.15/bbl over the next seven days with a negative volatility to price relationship playing a particularly marked role. Oil futures markets remain bearish, too. 

StanChart has reported that the ICE Brent contract saw 17.29 mb of net buying over the past week, while the ICE WTI contract saw 10.77 mb of net selling. However, money managers are overall short oil, with the positioning indices for the main oil product contracts all negative. Thankfully, the limited extent of that short suggests that the bearishness is far from being overextended.

Another bullish catalyst: India’s oil demand remains healthy. Data by the Government of India’s Petroleum Planning and Analysis Cell (PPAC) shows that India’s oil demand in April averaged 5.295 mb/d, good for 6.3% Y/Y growth. Fuel demand growth was mixed, with gasoline demand jumping 14.1% Y/Y while diesel demand grew at a more sluggish 1.4% clip. StanChart has predicted that India’s oil demand will expand by 265 kb/d Y/Y in 2024, slower than April’s 313,000 Y/Y increase but significantly faster than the International Energy Agency’s (IEA’s) forecast of 180 kb/d growth.

Meanwhile, the natural gas rally appears to have lost some steam, with Henry Hub prices pulling back from a three-month peak of $2.20/MMBtu on May 5 to $2.18 on Wednesday’s intraday session. Henry Hub prices have jumped 35.4% since April 26 on the prospects of Europe cutting off more Russian gas and predictions for increased cooling demand in the U.S. Dutch Title Transfer Facility (TTF) prices have also risen strongly over the past week, reversing almost all the YTD decline. TTF for June delivery rose EUR 3.738 per megawatt hour (MWh) to settle at EUR 31.801/MWh on 6 May.

However, it’s doubtful whether these gains in gas prices will hold with European weather having reverted to a more normal pattern after the recent cold snap, and the gas injection season resuming. According to Gas Infrastructure Europe (GIE), EU gas inventories stood at 73.65 billion cubic meters (bcm) on 5 May, 17.85 bcm above the five-year average.s