Oil On A Slippery Slope
Oil On A Slippery Slope
Revising our target price lower, plus ways to express it.
Earlier this week, both Brent and WTI traded to fresh 52-week lows. The picture and outlook for oil has become considerably more murky over the past couple of weeks.
WTI has now given back all of it’s year-to-date gains, and is down 3.74% in 2024:
We have revised down our 3-6 month forecast for WTI down to $60 per bbl, something our paid subscribers can see (along with our snapshot thoughts on other asset classes) in our House Views tab.
Today, we wanted to run through why the bearish case for oil has picked up steam and some trade ideas to express this view.
China! (Again)
We’ve lost count of the number of times this year that we’ve poked around in Chinese assets, wondered if we should invest, decided to sit on our hands for another month, and then did nothing.
The fundamental drivers behind the Chinese economy haven’t been great for some time now, and in our view, it’s a case that just because something is cheap, it doesn’t mean it can’t get cheaper.
Anyway, we’re not here to discuss China’s investment options but rather to explain why a sluggish China is hurting the oil price. July customs data showed oil imports were at the lowest level in two years.
The data that was released earlier this week showed that although August arrivals was higher than the July figures, it was still below August 2023.
Further, the jump in August can also be partly attributed to the fact that cargoes recorded in this month would have been arranged in June/July, at a point when oil prices took a dip lower. So, the actual driver behind this could potentially be taking advantage of the price fall rather than being backed by tangible demand.
Aside from this specific oil data, other elements of the economy don’t inspire confidence that a boost to demand will come anytime soon. For example, Caixin Manufacturing PMI’s showed contraction in July, with a reading of 49.6, the lowest level since October 2023. Even though the August figure managed to scrape above 50 (50.1), it still doesn’t correlate with a manufacturing powerhouse.
The consumer is also weak in China. Consumer confidence data over the past five years is shown below with no real comment needed:
Bottom line: China demand is unlikely to recover in the coming 3-6 months.
OPEC+ Cuts
As a brief explainer, OPEC+ is a coalition that includes 13 member countries and ten additional oil-producing nations, including Russia, Kazakhstan, and Mexico. It was formed in 2016 after a significant decline in oil prices, with the goal of coordinating production cuts and decisions to balance supply and demand.
The cartel has had a production cut in place since November 2022, but more voluntary cuts have been in place since the start of this year. They were expected to be phased out but have been kept on as a bid to try and offset the lower demand dynamic.
At a meeting last week, the group said they would delay by two months a plan to unwind voluntary production cuts that were due to start in October.
Yet as far as we can tell, the cuts that are in place this year haven’t had any material impact in supporting the oil price. From our rough calculations, we feel that we’d need to see an additional 2-4 million barrels of cuts per day in order to signal a meaningful change to the market.
In the latest OPEC monthly report, world oil demand is expected to fall. Note the shrinkage in the red bar (China):
“The world oil demand growth forecast for 2024 is revised down slightly to about 2.0 mb/d, which is still well above the historical average of 1.4 mb/d seen prior to the COVID-19 pandemic. This minor adjustment of 80 tb/d reflects mainly actual data received year-to-date.
OECD oil demand is expected to grow by around 0.1 mb/d in 2024, with OECD Americas accounting for the entire growth. Non-OECD oil demand is expected to grow by around 1.9 mb/d.
The forecast for world oil demand growth in 2025 is also slightly revised down by a mere 40 tb/d to stand at 1.7 mb/d. Non-OECD demand is set to drive next year’s growth, increasing by about 1.6 mb/d, led by contributions from China, the Middle East, Other Asia, and India. OECD demand is forecast to expand by about 0.1 mb/d, with OECD Americas contributing the most.”
Bottom line: OPEC+ cuts aren’t materially impacting the price. Unless extensive cuts are made, it won’t act as any support.