Commodities Report:
– Ole Hansen, Head of Commodities Strategy, Saxo Bank
Summary: Crude oil remains stuck in a tight range, with Brent and WTI having struggled all month to gain a foothold above $80 and $75, respectively. However, a succession of higher lows since December, when the Red Sea crisis began, point to limited selling appetite from traders worried that geopolitical tensions in the Middle East may escalate to threaten supply from key producers in the region. A focus that has seen speculators increasingly focus on Brent at the expense of WTI. Also, today’s weekly EIA crude and fuel stock report is likely to be distorted after the recent cold ‘bomb’
disrupted production while increasing demand for heating oil and diesel.
Crude oil remains stuck in a tight range, with Brent and WTI having struggled all month to gain a foothold above $80 and $75, respectively. However, a succession of higher lows since December, when the Red Sea crisis began, point to limited selling appetite from traders worried that geopolitical tensions in the Middle East may escalate to threaten supply from key producers in the region. While such an outcome stays very unlikely, the risk has nevertheless managed to support prices which otherwise may have traded lower amid ample supply and soft demand.
In WTI, a sustained break above $75.50 could see it target the 200-day SMA at $77.6, with $80 being the next major psychological level after that. The rising trendline is currently providing support at $71.
Large money managers such as hedge funds and CTA’s have, since early December when the Red Sea crisis started, increasingly been diverging their crude oil exposure away from WTI towards Brent. According to weekly Commitment of Traders reports provided by the major futures exchanges in the US and Europe, the combined net long in WTI and Brent slumped to a 12-year low in early December at 171k contracts or 171 million barrels, with the split between Brent and WTI being 57% and 43%.
However, the combination of the Red Sea crisis disrupting normal supply routes and rising US production has since then triggered a major divergence between the two. While the general rally in crude oil from the early December lows has seen the total net long jump by 85% to 317k contracts, the split between Brent and WTI has decisively moved in favour of Brent, with 72% of the total net long being Brent. Investors appear to have concluded production growth will continue to pressure prices in the United States while the Middle East conflict will provide some support for prices in Europe and Asia.
A development that is being supported by front-end futures spreads as the three-month spread in Brent has widened to 95 cents per barrel, giving the long-only investors a three-month annualised carry of 4.8%, while the similar spread in WTI only gives a 2.1% carry, a difference that matters to investors, making Brent more attractive from an investment perspective.
Later today, the EIA will release its weekly crude and fuel stock update with expectations inserted in the above chart. The report, however, may show several anomalies after the recent cold ‘bomb’ in the US temporarily cut production of oil and gas due to freeze-offs – when low temperatures freeze wells and other equipment while temporarily driving a spike in demand for fuels, especially diesel and heating oil. According to the American Petroleum Institute (API), crude stocks fell nearly 7 million barrels last week while gasoline stocks jumped by a similar amount, with distillates, such as diesel, jet fuel and heating oil showing a small decline. As mentioned, the report is likely to be distorted, but the market will still pay attention to gauge how big the impact of the freezing weather was.
We see an increased likelihood of crude oil staying rangebound in the coming months, with no single trigger being strong enough to change the dynamics of a market that has divided its focus between growth worries, not least in China and the USA, as well as rising non-OPEC+ production on one hand and OPEC+ cuts and geopolitical risks on the other. On top of this, we may see risk appetite ebb and flow in line with changes in the expected pace of US rate cuts.
With that in mind, we see Brent crude oil remain rangebound around $80 per barrel during the first quarter, but with disruption risks, OPEC+ production restraint, and incoming rate cuts potentially leaving the risk/reward skewed slightly to the upside. The biggest downside risk is a disunited OPEC+ leading to a collapse in the current agreement to keep production down, and the upside from a major geopolitical event disrupting the flow of crude oil and gas from the Middle East.
