Oil Market Sees Weakest Period Since June as Prices Retreat
The oil market is currently experiencing its weakest period since late June, with prices and calendar spreads plummeting since the end of September. This decline has reversed much of the remarkable increase seen over the previous three months. The retreat in prices and spreads for U.S. crude futures (NYMEX WTI) has been even more severe than that for Brent.
Experts believe that the collapse in the oil market can be attributed to rising interest rates and a deteriorating outlook for the global economy, which in turn has impacted the outlook for crude consumption. In October, benchmark yields on 10-year U.S. Treasury notes reached a 16-year high as traders predicted that the U.S. central bank would need to maintain higher overnight interest rates for longer to control persistent inflation. Furthermore, manufacturers in the United States, Europe, and China reported worse business conditions in October, undoing some of the gradual improvement seen between June and September.
On the production side, U.S. crude and condensate output exceeded pre-pandemic records in August, defying expectations that it would decline in response to falling prices since mid-2022. However, the limited changes in production and consumption over the past two months do not explain the rapid drop in prices and spreads.
The significant increase in nearby futures prices, followed by an equally sudden collapse, suggests a short-covering rally and a squeeze on deliverable supplies that has since unwound. Between the end of June and the end of September, total U.S. petroleum inventories, including the strategic reserve, increased by almost 15 million barrels. However, commercial stocks of crude oil decreased by 38 million barrels, with over 21 million barrels depleted at Cushing in Oklahoma, the delivery point for the NYMEX WTI contract. Surprisingly, Cushing accounted for 55% of the nationwide depletion despite holding less than 10% of all crude inventories at the end of June. There were only minor depletions in the rest of the Midwest and along the Gulf of Mexico, with insignificant changes elsewhere.
Cushing inventories experienced consistent depletion between the end of June and the end of September, unlike the rest of the country. This draining of deliverable stocks caused the WTI futures contract to reach near-record backwardation by the end of September. There is a clear correlation between the drawdown in deliverable stocks and the increase in the nearby backwardation.
Hedge funds and other money managers were forced to reduce bearish short positions in NYMEX WTI from 136 million barrels at the end of June to 20 million barrels at the end of September in response to rising prices. This reduction in bearish short positions anticipated, accelerated, and amplified the rise in prices, creating a self-sustaining increase in both spot prices and spreads. By the end of September, bullish long positions outnumbered bearish shorts by a ratio of 16:1, compared to 2:1 at the end of June.
However, since then, prices and spreads have collapsed, despite minimal changes in U.S. crude inventories at Cushing and elsewhere. Fund managers’ short positions have again increased to 75 million barrels, and bullish longs now outnumber bearish shorts by a ratio of just 3:1.
Throughout October and early November, the unwinding of the squeeze and the end of short covering were overshadowed by the sudden increase in violence in the Middle East, which posed a threat to crude oil production. As the risk of escalation has seemingly diminished, the unwinding of the squeeze has become more apparent and has intensified the downward pressure on nearby futures prices. In reality, the market was never as tight as prices and spreads suggested in late August and September.
Currently, the market has returned to a more neutral state. Both Brent and WTI prices are almost exactly in line with the average since the start of the century. While six-month spreads for both WTI and Brent are slightly higher than the long-term average, this reflects the fact that crude inventories are moderately below average for this time of year. U.S. commercial crude inventories are approximately 9 million barrels (2% or 0.22 standard deviations) below the prior ten-year seasonal average.
Overall, the oil market is now in a neutral state, neither bullish nor bearish, compared to the strongly bullish conditions that were observed in September. The production restraint by Saudi Arabia and its OPEC⁺ partners is being counteracted by continued growth in non-OPEC output and a downgraded outlook for global growth.
More detail via Reuters here… ( Image via Reuters )