Standard Chartered Thinks Oil Prices Are Flirting with Risk Denial

Oil markets continue being stuck in limbo with oil prices so far failing to achieve any significant momentum in the new year. Commodity analysts at Standard Chartered have made an interesting observation that front-month Brent has touched $77.97/bbl for 12 consecutive trading days, including the last trading day of 2023. StanChart says this situation is unlikely to change in the near-term, with its proprietary machine-learning model dubbed SCORPIO predicting minor changes in oil prices over the next week.

Last week, StanChart reported that sentiment in the oil and commodity markets closely mirrors the beginning of 2023. At the start of 2023, money managers were bullish on gold, gasoline and platinum; neutral on copper but very bearish on crude oil and palladium. They were [mostly] right on the money: Most energy commodities finished the year with deep losses with heating oil, coal, gasoline, ethanol, refining spreads all recording double-digit losses; WTI and Brent finished with high-single-digit losses while natural gas futures were cut by nearly half.

Meanwhile, gold posted double-digit gains while palladium tanked 40%. Standard Chartered has revealed that positioning in crude oil and metals is very similar to year-ago levels. According to the experts, sentiment on other commodities also remains largely unchanged with silver and distillates the only commodities whose sentiment and positioning has shifted significantly from a year ago. StanChart says there’s a clear pattern of demand pessimism once again dominating most commodity markets.

Oil traders fear that market surpluses will be larger in the current year than they were last year, with the key difference being that traders expect the U.S. and Europe, not China, to be the main sources of demand weakness this time around.Energy stocks have also kicked off the new year on the backfoot, with the Energy Select Sector SPDR Fund (NYSEARCA:XLE) down 5.5% in the year-to-date compared to a tamer 0.2% drop by the S&P 500. But all is not lost. Goldman Sachs has reported that stocks of companies with weak pricing power typically outperform as profit margins improve, noting that such stocks are currently trading at a 14% P/E discount to stocks with strong pricing power. GS has picked Ovintiv Inc. (NYSE:OVV) and Chesapeake Energy Corp. (NASDAQ:CHK) as energy stocks that could outperform as margins expand.

Interest Rate Jitters

Oil prices have also come under pressure because of interest rates. Commercial interest rates have been ticking higher over the past three weeks due to uncertainty regarding when, and by how much, the Fed will cut rates, a trend that has strengthened the U.S. dollar. At its last meeting held in December, the central bank announced that its nearly two-year battle against inflation was nearly won and that a series of interest rate cuts would follow in the current year. The markets have priced in a 71.4% likelihood of at least a quarter-point cut in March and up to seven cuts by the end of 2024.

Unfortunately, the latest inflation data suggests the Fed might not be as aggressive as traders hope: December consumer price index re-accelerated thanks to an uptick in the cost of energy, food and rent.Wall Street has tempered its expectations of the number of rate cuts we are likely to see in the current year.Goldman Sachs has predicted the Fed will make a total of five cuts in 2024. 

The Fed will start cutting the funds rate soon, most likely in March. After all, Chair Powell said at the Dec. 13 press conference that the committee would want to cut ‘well before’ inflation falls to 2%. However, we expect ‘only’ five cuts this year, below the six-to-seven cuts now discounted in market pricing, and we view the chance of 50 basis point steps as low,” the strategists wrote.

Bank of America and UBS are more bearish, and have predicted four rate cuts this year, beginning in May; Wells Fargo is very bearish, with the economists having penciled in just three reductions. Thankfully, the latest quarterly economic projections have revealed that a majority of Federal Open Market Committee officials expect the cuts to extend all the way to 2026.

Natural gas markets are more bullish than their crude brethren. Cold weather coupled with a relative lack of wind-power generation have triggered a sharp acceleration in EU gas withdrawals over the past week. Europe’s gas inventories decreased by 1.32 bcm on 15th January 2024 to 92.31 billion cubic meters (bcm) on 14 January, with the rate of withdrawal good for an increase of 14.76 bcm above the five-year average. 

Unfortunately, Europe’s gas inventories remain high, and the large inventory draw has failed to trigger a rally. Front-month Dutch Title Transfer Facility (TTF) gas settled at EUR 29.923 on 15 January, 54% lower y/y and 66% lower than in January 2022. In sharp contrast, lower supply and extreme cold weather in the United States has helped Henry hub gas prices climb 13.3% year-to-date though prices are 15.2% lower than year-ago.