The oil market has been extraordinarily rangebound over the last two months in view of the uncertainties it faces. Brent has been in a 65 to 70 \$/b range since early August and did not stray much above that during July. There appears to be a strong consensus that the market will be oversupplied in the remainder of this year, indeed, in its latest Monthly Oil Report (click here) the International Energy Agency (IEA) talked about global oil inventories rising by "an untenable 2.5 mb/d on average in 2H25 as supply far outstrips demand". Such a situation could be expected to lead to a steeply upward sloping forward curve that would be necessary to cover the cost of the anticipated storage, which would force the Brent front contract down. Whereas, what we actually see is Brent trading in the mid to high 60s, with a forward curve that is modestly downward sloping, indicating that the market is tight. This is in spite of the fact that the positions of speculators on futures exchanges look to be anticipating bearish developments. This is particularly the case for US WTI, where the long and short positions of speculators are almost balanced, whereas there is usually an inherent and substantial, long position as some investors favour being long oil for diversification reasons. Why then has the price of oil not collapsed?
One strong contender as an explanation, is Chinese inventory building. At the start of this year, China enacted the Energy Law that covers all aspects and types of energy supply and use. This included a chapter on emergency energy reserves that stipulates that "the state shall establish and improve an efficient and coordinated energy reserve system […] and give full play to the strategic guarantee, macro-control, and emergency response functions of energy reserves." As well as state owned reserves, the law also mandates for the build-up of commercially owned reserves. China’s interest in increasing its reserves to protect it against external shocks, has of course taken on greater prominence since Trump showed a willingness to use trade policy to dissuade countries from buying Russian oil, as it has already done with India. China’s build up of reserve is not reported in any transparent way, so it is not clear how much it has built up or for how long it can continue to absorb surpluses.
It is also possible that the forecast surplus does not materialise, or us much more modest. US supply growth has stalled and while there is much talk about the eight OPEC+ members unwinding their additional voluntary cuts, the fact is, a number of members are already producing more than their targets and others face output constraints. The only material OPEC+ member that needs and is able, to increase output when targets are raised, is Saudia Arabia. To put that in context, Saudi Arabia’s contribution to the surprise output increase announced at the start of this month, amounted to only around 0.04% of global supply – essentially a rounding error and perhaps offset by pressure on Russian output from Ukrainian strikes on its oil infrastructure.
Geopolitics, continues to be source of uncertainty. While, Trump has already placed additional tariffs on India for buying Russian oil, he appears unwilling to go further for now, unless Europe stops buying Russian energy and perhaps applies its own tariffs to deter countries from buying energy from Russia. While the latter looks unlikely to happen, the EU announced this week that it would bring forward plans to phase out usage of Russian oil and gas, leading to a modest rally.
In the face of this uncertainty, perhaps it is reasonable for the market to drift along as it is. However, one lesson from the history of oil markets, is that periods of low volatility and range-bound trading can end abruptly. The 65 \$/b support level is relevant in that respect. Oil has found support there over the last two months, but if it is broken, the door could be open to a return to the 60 to 65 \$/b range from April and May and possibly lower. On the upside, the market has shown some tendency to break higher on positive news, due to the relatively bearish outlook of speculators as mentioned above. So far this has been met with renewed selling and rallies have not made much progress since Brent rallied up to 80 briefly during the height of the Iran-Israel conflict. A determined effort to reduce Russian exports to world markets could be the catalyst for such a rally. However, it would be difficult to avoid a situation where a modest reduction in Russian exports leads to such high prices for the remainder of its output, that Russia’s revenues are protected – perhaps making such a policy unlikely. If the market does move higher, up through 70 $/b, it is possible that the momentum brough about by short covering, could lead to prices advancing rapidly. The 73 \$/b area high from late July is one level to look out for, but above that there is not much until the June high over 80.
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