Oil Is Not Out of the Woods Yet

Oil prices started the week with a gain after slumping to the lowest in nearly three years, with analysts of a mostly unanimous opinion that bearish factors are stronger than bullish ones, regardless of their actual weight. Some even believe prices will fall further before a correction begins.

Morgan Stanley, for instance, revised down its Brent crude forecast for the fourth quarter to $75 per barrel from $80 per barrel. Swedish financial major SEB concurs, with its chief commodities analyst also putting Brent’s average at $75 per barrel—in 2025. Bjarne Schieldrop added, however, that prices typically move within a $15 range from that figure.

BCA Research is also pessimistic about the potential for oil prices to break out of their current, increasingly lower, range. Roukaya Ibrahim, BCA’s commodity and energy strategist, said recently in a note that the worst for oil prices was yet to come after speculators turned net bearish on crude for the first time since record-keeping began.

“The cyclical global growth outlook ultimately suggests that the worst has not yet passed for the oil market. The path of least resistance for prices is to the downside over a six-to-nine-month horizon,” Ibrahim said, adding that “Investors who are long oil should cut back their exposure in anticipation of lower prices ahead.”

All this does not sound good for those betting on a rise in oil prices in the observable future. Yet prices are up this week, extending a climb that began last week on supply disruptions in the Gulf of Mexico. This week, the climb is being fueled by the U.S. Federal Reserve, which is later today expected to announce the first rate cut after four years of hikes aimed at stemming the progress of inflation.

A rate cut would probably buoy oil prices for some time as it would signal the U.S. economy is truly on the mend, and those who talked about a soft landing knew what they were talking about. The interesting question is how long the potential rally would last and how high prices would go before Chinese demand disappointment settles back over oil markets.

Another interesting question is when those markets will get used to the fact that Chinese demand is unlikely to return to double-digit growth rates, and oil bets begin to reflect that new, calmer reality. It might be a while, judging by current sentiment, with market analyst John Kemp noting that “crude prices have retreated to levels last seen when the major economies were still in the grip of the coronavirus pandemic and the first successful vaccines had only recently been announced.”

This seems a bit excessive, seeing as there are currently no pandemic lockdowns anywhere, and demand for crude oil has certainly recovered from the trough of 2020. Bloomberg has noted in several reports that CTAs—commodity trading advisors—tend to amplify price changes because they follow technical trends and disregard fundamentals. This probably had a part to play in the latest rout and the net bearish record on the futures market. A pessimistic economic outlook also had a part to play.

“The weakness is at the back of the market,” Black Gold Investors fund manager Gary Ross told Bloomberg recently. “The industry is bearish 2025. The financials drive the flat price and are hugely short by historical standards — they are clearly pricing in a very poor economic outlook.”

The Economist Intelligence Unit recently noted U.S. elections as a factor creating uncertainty about the global economic outlook and also slowing U.S. growth as a bearish factor. Finland-based Nordea said all major economies were witnessing weak growth, noting that “This could encourage China to ease fiscal policy further, and the Western central banks are expected to cut rates. With a delay, both actions should bring more stability to the growth numbers.”

McKinsey noted that growth has been weak but took a more optimistic stance in its latest update, noting that even though it was slow, growth was still present in all the major economies, moving faster in developing nations. In China, the consultancy said that GDP growth over the first half of the year was a healthy 5%.

All this suggests that physical demand for oil is not about to plunge, and positive fundamental news will eventually reach the futures market and change traders’ behavior. Meanwhile, the focus would be on potential supply disruptions and geopolitics as the situation in the Middle East remains extra-tense, although it has so far failed to lead to the abovementioned disruptions.

Everyone seems to be looking at OPEC+, which has planned to bring back some supply starting in October but delayed that because of low prices. Meanwhile, U.S. producers are beginning to slow down production growth because lower prices are not something they like in the usual supply adjustment to demand perceptions. This production growth slowdown is happening gradually, and few are paying attention because the watchers are too busy watching OPEC supply and China demand. It could, however, eventually swing the market into a deficit.