August 31, 2024
Beware of Sheiks bearing leaks on the Friday of a gasoline-intensive U.S. labor holiday weekend
Item 1: Reuters, citing unnamed sources, reports OPEC+ “is set to proceed with a planned oil output hike from October”. This is a curiously timed piece of non-news. Take careful note: the article describes a potential increase of supply. If a hike happens on plan, it will start, gradually, one month from now. An equal-measured pace by OPEC+ would bring back 180 thousand b/d per month, offsetting about one quarter of the present realized loss in Libyan production flow if the Libyan cut were still in place one month from now. Whether any OPEC+ supply hike happens one month from now (or earlier) and what “gradually” means are both expressly contingent on market conditions.
Item 2: Libya’s National Oil Company reports the crude oil production cut in Libya has now reached 725 thousand b/d. This is a realized loss of supply. It is reality. Right now.
Whatever happens or not a month from now, here’s the reality of market conditions today: the actual loss of 725 thousand b/d of Libyan supply is rapidly tightening the Mediterranean crude balance. This is transparently visible in a price spike that occurred in physical market spreads in the Med earlier today.
This realized physical market oil price spike heading into the gasoline-intensive US Labor Day holiday weekend, in a fraught U.S. presidential election year, in the context of active military operations in the Mideast and Russia, immediately suggests one motivation why unnamed OPEC+ sources might want to float a trial balloon through Reuters to signal they are prepared to fill in a Libyan supply gap and contain an oil price spike if needed.
Okay. But why such an energetic futures price reaction? Why give greater weight to the thing that is not yet happening (OPEC+ supply hike) than to the thing that is (OPEC+ supply cuts)? Good question. Equity investors who are puzzling over today’s sudden slump in crude futures prices should be aware of three other facts about the oil futures dynamics at work here.
First: today is the expiry date of the Oct-24 ICE Brent crude oil futures contract (COV4), which is a cash settled instrument. Coming into today, there were still 74,281 lots of open interest in this contract (US$5.9Bn of risk), according to exchange data. These positions closed at $80 last night with many factors that could have propelled them higher today, including Libya in the absence of a Reuters story.
Second: today is also month-end. Futures traders have heightened sensitivity about today’s marks of their performance in the cash-settled Brent market. Positions need to be squared now. OPEC+ risk can be addressed next week.
Third: notice that today’s intraday price hit was stronger in WTI futures than in Brent futures. We would offer three reasons: (1) institutional investors in WTI have been more bullishly positioned than investors in Brent, so we are observing some reduction in their positions, (2) the prompt Oct-24 WTI contract (CLV4) will still be active on Tuesday and for another three weeks, but the prompt Oct-24 ICE Brent contract (COV4) dies today—the contracts are pricing risk premia over two different time horizons, and (3) if OPEC+ were to return oil supply gradually on plan a month from now (or earlier/faster/larger, which is a real risk), then US export barrels would be most likely to be displaced, transmitting a bearish price impulse back to the U.S. wellhead.
Today is more about flow than fundamentals. A reversal soon would not be surprising. At the same time, we do want to take downside price risks for oil seriously. As I noted earlier this week, our own models put the risk of a sub $65 expiry at close to 40%, or 2X what the NYM options have been suggesting. But we also need to keep realized events and potential events in proper frame. If an oil price flush occurs in the next three months, it is more likely to be a deliberate push from the supply side than a collapse from the demand side. And the most likely outcome at expiry in these risky markets is higher crude prices than today.
Comments