Oil Oversold After Macro Fears Hit Market

The macroeconomic fears in the wake of the latest banking crisis have tripped up oil, leading to a 10% plunge in prices.

How worried should investors be about the sell-off spreading? Fears of contagion in markets currently dominate sentiment in oil trading. The macro-environment looks set to weigh heavily on oil this year — just as geopolitics did last year after Russia invaded Ukraine.

Oil prices are currently being moved less by supply and demand fundamentals and more by concerns that a banking crisis could spill over into the physical economy, slash consumer spending and prompt a recession that would knock oil demand.

That could be problematic for a well-supplied oil market — at least for now —and spell continued pressure on prices. But that’s hardly guaranteed.

Benchmark crude prices Brent and West Texas Intermediate (WTI) have already tumbled to 15-month lows at $74 and $69 per barrel, respectively.

An oil market already fixated on rising interest rates, persistently high inflation, and industrial weakness now has the health of the global banking system to consider after the recent collapse of Silicon Valley Bank and the rescue of Credit Suisse by UBS.

With the economic growth outlook growing cloudier, a recession seems inevitable. The only question is how severe the downturn will be.

If central banks like the U.S. Federal Reserve continue to raise interest rates, markets – including oil – will likely price in the chance of a much more painful recession.

Meanwhile, the realignment in financial markets has forced banks and other financial speculators to exit many of their past bets on rising oil prices, adding more pressure to the market and weakening the futures curve.

The question now for oil is whether this was panic liquidation and whether the market was oversold.

The bet is that it was. While oil markets are currently well supplied, that’s not expected to happen later this year. The supply slide into deficit could be significant.

A much-anticipated recovery in China’s oil demand has yet to materialize, mainly because Chinese refiners are drawing crude from their stockpiles to satisfy domestic demand. But Chinese demand will inevitably return.

And while Russian production has proven more resilient to Western sanctions than initially thought, when the dust settles, Russia’s average output will be about 1 million barrels a day lower than its 2022 average. Even OPEC predicts a 900,000 barrels a day drop in Russian production this year – and it counts Moscow as a critical member of the extended OPEC-plus cartel.

It all points to a dramatic shift from supply surplus to deficit in oil markets in the second half of the year. Indeed, oil demand growth was always projected to be backloaded more to the latter half of 2023.

The International Energy Agency (IEA) recently predicted that global oil demand would rise by 3.2 million barrels daily between this year’s first and fourth quarters. That would be the most significant gain in a calendar year since 2010.

All told the IEA sees demand growing by 2 million barrels daily to an annual record 102 million barrels daily this year, including a peak of 103.5 million b/d in the fourth quarter. The growth will be driven by China’s economic recovery and a post-Covid rebound in global air traffic.

Crude supply tells only half the story in petroleum markets. Petroleum must be refined into consumer products like gasoline, diesel, and jet fuel. And these markets are tighter, as reflected by refiners’ robust profit margins. So long as these margins remain strong, refiners will continue to buy crude and support high oil prices.

And if all else fails, there’s always OPEC-plus to backstop the market. The oil cartel showed last year that it would take action to defend prices, deciding to cut production by 2 million barrels a day in October even though the Saudi-led group knew it would anger the Biden administration. OPEC-plus made that call when oil prices were around $90 a barrel, and recession fears were mounting.

To be sure, the macro environment is cause for concern. But it also requires a dose of oil market realism.

The economic outlook is murkier, with cracks in the banking system now exposed. It’s why Goldman Sachs this week backed off its $ 100-a-barrel forecast.

Less reported was the news that Goldman still expects Brent to trade at an average of $94 a barrel for the next 12 months and $97 in the second half of 2024.

Baron Rothschild famously said that the time to buy is when there’s blood in the streets. There may not be blood in oil markets, but it isn’t pleasant, and there’s definitely money to be made.