At the end of 2023, a key question for the oil market was whether OPEC+ members that signed up to additional voluntary cuts coming into force on 1st January, would deliver on them? Would OPEC+’s rather loose approach to cutting output be sufficient to deal with demand weakness concerns that worried the oil market over the last quarter of 2023?
The focus has since shifted to the logistical challenges of moving crude and refined products around that have been created by the repeated Houthi attacks on vessels moving in and out of the southern end of the Red Sea. Attempts by the US and other western militaries to protect vessels have not proved very effective nor have efforts to degrade their ability to launch attacks by strikes on infrastructure on land. The Houthis have claimed they are targeting US, UK and other countries they perceive to be supporting Israel, but the attacks appear much more indiscriminate in practice. Indeed, one of the most effective of their largely inaccurate attacks, was on vessel carrying Russian oil products.
The conditions for these attacks to end would presumably either be an end to the war in Gaza under terms the Houthi’s deem appropriate, or a much more involved military operation led by the US, to put a stop to the attacks by force. Neither of these looks very likely at the moment.
However, the impact of the attacks on crude prices has been limited because: crude from the Middle East tends to go east to Asia these days rather than west to Europe and the US, the largest crude carrying vessels do not fit through the Suez Canal and because the cost of additional sailing time around Africa amounts to little more than 1\$/b anyway. Consequently, crude has rallied, but not dramatically so. The challenge has been greater for refined products like jet fuel, as there are significant imports into Europe from Asia and the Middle East that would normally come through the Suez Canal on smaller vessels. This has generally led to a widening in the premium of jet fuel prices over Brent (the Jet crack).
In the last few weeks, Brent has regained a measure of its historic behavioural tendency to track equites. As the S&P 500 scaled the giddy heights of 5,000 for the first time, Brent has rallied up through 83 \$/b again. This appears to be the result of increasing investor interest in Brent futures. As the chart of Managed Money positions below shows, bullish speculative positions are at their greatest extent for 2-years. As equity prices increase, investors tend to rebalance their portfolios, leading to money flowing into oil. The charts shows that Brent has been a particular beneficiary of investor inflows as compared to US WTI. Refined products do not tend to attract this kind of investor interest, however and the premium of jet over Brent has been eroded somewhat as a consequence.
From a technical point of view, Brent has broken out of the downtrend since September last year, but has so far been constrained by the 85 \$/b figure that it came close to touching at the end of January, as it did in November last year.
Where do we go from here? Returning to the original question concerning OPEC+ attempts to manage lacklustre demand, January output from the group was indeed lower than December 23 according to the International Energy Agency’s (IEA) latest report. Production from OPEC+ dropped by around 300kb/d. Based on the IEAs forecasts for this year, if OPEC members maintain their January output level throughout this year, the market will be in a modest surplus (around 200 kb/d) in the first quarter and balanced on average over the year. If demand does surprise on the upside Saudi Arabia, in particular, has plenty of spare capacity it can bring on-line to satisfy the market. This dynamic ought to prevent sustained high prices from a macro-economic driven demand surprise. A geopolitical surprise, like Iran disrupting shipping through the strait of Hormuz, thus hampering most production from the Middle East, would be an entirely different matter. The market clearly ascribes a low probability to that as things stand. The US carried out retaliation to attacks on its base in Jordan and nothing further has happened. Meanwhile the distribution in the Red Sea may already be having as much impact as it is ever going to have. Consequently, while a breakthrough 85 \$/b, could lead to upward technical momentum that may initiate a significant rally, an opening of Saudi taps could lead to that being short lived.
It is harder to see how OPEC+ can handle a downturn, given how far Saudi Arabia has already cut on a voluntary basis and that other members have been unwilling to contribute. There are various risks on the horizon, that could undermine actual or expected demand growth. A correction in arguably over extended US equity markets, problems in the Chinese property market coming home to roost and the economic travails of Europe are all examples.
In the short term, if Brent can keep away from 80 \$/b there is scope for it to test 85 \$/b and, if it can break it, carry on towards 90 \$/b. On the downside, below 80 \$/b is the 50-day average around 79 \$/b, followed by recent lows at 76.60, 75 and 72 \$/b.