Why Oil’s 7-Month Downturn May Be About To Reverse

As OilPrice’s Alex Kimani writes, oil prices have kicked off the new year on the back foot, tumbling to large losses in the first week before staging a modest recovery in the second as demand uncertainty continues to weigh on trading. Concerns over the rapid expansion of China’s COVID cases, following the relaxation of strict zero-COVID policies have continued to weigh heavily on oil prices.

Commenting on oil’s recent lethargy, Goldman trader Rich Privorotsky writes that for all the excitement on China re-opening, time spreads in WTI remain negative (2m-3m) and are trading at 1m lows and “something just doesn’t quite jive between the optimism flooding back into cyclicality versus an oil price which should have lot more going for it given”

1. low US inventories

2. a de facto put from the SPR <70

3. issues on Russian supply/exports

4. China re-opening expectations becoming fully entrenched.

Incidentally, Privorotsky notes that copper does not share the concern, breaking out above the recent range: “perhaps the relative pricing differential is a reflection on China growth relative to growing concerns about US growth…a thematic which is very clearly reflected in equity performance over the last couple months. Keeping an open mind, seems market is chasing short term momentum with investors keen to re-deploy capital/chasing what has recently been working.”

Luckily, for oil bulls, reprieve could be on the way with oil markets having reacted positively to China re-opening its borders on February 8, 2023 as one of the final acts of abandonment of the zero-Covid era. More relief is expected to come thanks to the Lunar New Year travel providing a short-term demand boost. Chinese Lunar New Year lasts for two weeks, and is set to begin on Sunday, 22 January 2023, and end on February 5, the date of the rising of the full “Snow Moon.” Indeed, the Civil Aviation Administration of China (CAAC) has predicted that passenger flights might reach 88% of their pre-pandemic levels by the end of January. However, this might only be a temporary bump unless China is able to move past its latest COVID wave before the oil markets feel confident about prospects of a sustained demand uplift.  But some experts are still holding out hope that the worst could be in the rearview mirror. Commodity analysts at Standard Chartered have expressed optimism that the prolonged selloff could have reached an inflection point, with the analysts saying that the seven-month long downwards trend is likely to falter now. The analysts say that the previous hyperbole that triggered a huge oil price rally has cooled off and has been replaced by excessive pessimism leading to oil prices undershooting their 2023 target.

StanChart points to the oil futures markets, where…

“…speculative positioning now reflecting an overly bearish viewpoint in our opinion and with crude oil the least popular positive exposure apart from palladium among investors, we think there is now short-term upside of USD 5-10/bbl, with more to follow in H2. With supply risks biased towards lower supply, and with OPEC patience likely to be strained by further attempts to push prices significantly below.”

The commodity experts have forecast that demand growth in 2023 will clock in at 1.04 million barrels per day (mb/d), with non-OECD countries providing all but 9 thousand barrels per day (kb/d) of that. Demand is expected to be stronger in the second half of the year, with H2 demand coming in at 101.1mb/d, 1.7mb/d higher than the H1 average. The analysts say much of that growth will come from the Asia-Pacific region where they have predicted that growth will accelerate from 177kb/d in 2022 to 852kb/d in 2023, with China seeing demand growth of 483kb/d compared to a 350kb/d decline in 2022.

At this juncture we could say the oil market is almost evenly divided between the bulls and the bears.

Hedge fund manager Pierre Andurand is wildly bullish, and recently came out and predicted that oil may top $140/bbl this year if Asian economies fully reopen after COVID-related lockdowns. According to Andurand, the market is “underestimating the scale of the demand boost [a full reopen] will bring,” also telling Bloomberg that oil demand could grow by more than 4M bbl/day, or ~4%, this year. Eric Nuttall, partner and senior portfolio manager at Ninepoint Partners LP, has told the Financial Post that oil prices will return to $100 per barrel in 2023 while Bank of America has predicted that Brent could quickly go past $90 per barrel on the back of a dovish pivot in the U.S. Federal Reserve and a “successful” economic reopening by China.

But there’s no shortage of bears, either.

Two weeks ago, Credit Suisse broke the hearts of the bulls after declaring that the selloff is not done yet, and Brent could see further downside towards the 61.8% retracement at $63.02 per barrel. Interestingly, Brent prices have given up another 4% since that dire prediction was made to trade at $80.75 per barrel, implying the downside risk remains huge. A week ago, famous oil broker PVM Oil wrote in a blog that,“There is no doubt that the prevailing trend is down, it is a bear market,’’ citing warm weather in Europe as well as China’s bing Covid woes. Another ominous sign: a week ago, Brent futures prices slipped into backwardation suggesting that traders believe that future oil prices will be lower than current prices.

Meanwhile, ING strategists see a weak Q1 but stronger prices from Q2 going forward, writing in a blog last week that, “The oil market is looking better supplied in the near term and risks are likely skewed to the downside. However, our oil balance starts to show a tightening in the market from the second quarter through to the end of the year, which suggests that we should see stronger prices from 2Q23 onwards.”