Brent crude has dropped from its highs of $135 a barrel on the spot market back in March as Russia invaded Ukraine and is trading now at $95 a barrel, struggling to hold on to any gains above $100 a barrel. At the time, the entire world was convinced that we were running out of oil due to inefficient policies of western governments toward clean energy transition and sanctions placed on Russian oil. Investment houses euphorically were calling for oil to rally all the way to $150 and even $200 a barrel.
However, it is never really that simple as commodity markets are not about the demand/supply balance today, but rather what that balance will be tomorrow. Many researchers base their view of that tomorrow by penciling in what has happened and they do not factor in what possibly could happen as the global economy shifts from growth to recession.
Alas, oil has fallen close to 40% and here on Tuesday morning Goldman in a desperate attempt to justify its calls has reduced its Brent second-quarter/third-quarter oil price forecast to a range of $110 to $125 a barrel from the previous $130 to $140 a barrel, citing zero Covid policies and whatever narrative it could find to justify the move, although still reiterating its bullish call for the future. Being bullish is all well and good, but if prices fall 40% or more only to rally a year or so later, that really is not helpful to investors as eventually a bullish call is bound to be right at some point in a cycle.
Commodities are all about timing and about assessing the demand versus supply balance. It is the former that is always the hardest as that tends to change over time as the cycles progress.
Earlier this year the war in Ukraine came at a time when we had a very cold winter, which left distillate inventories short at a time the world was still growing given the Covid-induced stimulus surge. But as this juice gets taken away global economies are crumbling, as seen in the PMI and ISM data and a host of other surveys as globally we are entering a recession, not a slowdown.
Most investors and central banks are debating the timing, failing to realize that we are already in one and nothing can be done because inflation is just too high. Their only tool to combat any economic weakness has always been to print more money. Today if they did that, we would be in stagflation for decades.
The oil markets go through seasonal cycles and currently we are in the peak of the summer driving season, which usually tends to see a spike in gasoline demand. However, this year given the high prices at the pump and the strain of macroeconomic factors on the US consumer, demand has not picked up at all but rather is falling. On a four-week moving average basis, gasoline demand this year is 8.8% below 2021 levels and is even below 2020 levels. This is how weak the underlying demand is.
These demand figures have not been priced in or penciled in by the same bullish investment houses that assume the world has stopped producing dirty fossil fuel altogether and that there is none left while demand is at all-time highs. In the case of commodities that is never the case, as we have seen in coal. It is always a matter of the right price and when there is a demand for it. Today with refinery margins at such lucrative levels given the initial product shortage, refineries were compelled to crank up volumes. Lo and behold, inventories are picking up. The tightness was there, but it is a matter of timing.
There is a secular case to be made for oil to trade higher for longer to incentivize supply if — and that is a big if — demand stays strong or if China comes back in full mode. All that Russian oil that was deemed lost found its way to China and India. The world’s biggest and third-largest crude importers, respectively, accounted for 1.85 million barrels per day of Russia’s total exports of 4.47 million barrel per day in July, according to data from commodity analysts Kpler. But July data have shown a slowing trend compared to earlier months. Could it be that they have enough of oil or don’t need as much even with the discount of at least $10 a barrel?
There are signs of a peak being reached in India’s appetite for Russian oil, with Kpler estimating July’s imports at 1.05 million barrel per day, down from 1.12 million barrel per day in June. For now, demand is falling at a time when supply is picking up, which can only mean prices can move further down, to the detriment of all the bullish sell side houses.