ANALYSIS: China, Middle East Erase Oil’s 2023 Price Gains

Volatility in global markets could persist heading into 2024.

A storage tank is labeled as containing crude oil in the Permian Basin in Mentone, Texas, on Nov. 22, 2019. Angus Mordant/Reuters

Global energy markets have shrugged off geopolitical tensions and have placed a renewed focus on supply factors. As a result, crude oil prices will record their third consecutive weekly loss, adding to their year-to-date declines.

West Texas Intermediate (WTI) crude futures are trading at about $77 per barrel on the New York Mercantile Exchange. Brent, the international benchmark for oil prices, is trying to regain $82 on London’s ICE Futures exchange.

Have investors turned sour on crude, or have traders baked many near-term factors into the cake?

Chinese economic data continue to disappoint financial markets.

In October, exports declined by 6.4 percent year-over-year, worse than the consensus estimate of 3.3 percent.

This represented the sixth consecutive month of sliding exports, signaling extended weakness in foreign demand.

Imports rose at a better-than-expected 3 percent annualized pace last month, surpassing the market forecast of negative 4.8 percent.

This included a notable 13.5 percent boost in crude oil imports and a 15.5 percent increase in natural gas purchases.

In the first half of 2023, China imported record volumes of crude oil because of national refinery expansions and efforts to reopen the post-crisis economy. It imported an average of 11.4 million barrels per day, up 12 percent from the same time a year ago.

But while the substantial jump in crude imports should have been enough to juice prices, a “big picture” view suggests that this isn’t that bullish, according to energy analyst Anas Alhaji.

“Usually, such an increase is viewed as bullish. Once we look at the big picture, it is not that bullish!” he wrote in an analyst note.

“China’s refinery runs and oil exports were declining while oil inventories were rising! However, the good news is that domestic demand has not weakened.

“The bad news is that the demand growth is not as strong as many have hoped.”

Deflation threats have also signaled weakening domestic consumption.

Last month, the annual inflation rate slipped by 0.2 percent, slightly below economists’ expectations of negative 0.1 percent.

The producer price index fell by 2.6 percent year-over-year, slightly less than the projection of a 2.7 percent drop.

On the demand side, it’s a mixed picture coming out of China, noted Warren Patterson, head of commodities strategy at ING.

“There are worries over Chinese demand going into the winter, though for much of the year, while there has been concern about the Chinese economy, oil demand numbers have performed strongly up until this point,” he said in a research note.

On and Off War Premium

Following the deadly Hamas terrorist attack on Oct. 7, U.S. crude prices popped by about 4 percent, topping $86 per barrel. This was below the 2023 high of $93.68, but the fear trade triggered a rally.

Since then, however, prices have eliminated their year-to-date gains.

The chief concern among analysts had been that the conflict in Israel would widen throughout the region and result in heightened sanctions on Iranian oil.

Tehran’s energy sector had enjoyed a renewed boom this year, with production and exports returning to 2018 levels.

At the onset of the war, the expectation was that a U.S.-led embargo on Iran’s energy sector would trim global supplies and exacerbate the international supply deficit, sending prices higher.

However, according to one market observer, investors have taken a step back and assessed other possibilities, including the impact of weaker Asian demand.

“The new market narrative is that, even if the Iranian oil gets banned, it doesn’t matter because first, the Iranian shipments have been falling due to weaker Asian demand, and two, 90 percent of the Iranian shipments go to China anyway, and China doesn’t care about the Iranian oil ban, they will continue buying it,” Ipek Ozkardeskaya, a senior analyst at Swissquote Bank, said in a recent note.

Venezuela could also play a role should supply from Iran become paralyzed, Mr. Patterson noted.

President Joe Biden and his administration established an agreement with the Venezuelan leadership to ease sanctions if Caracas oversees fair elections in 2024.

If the terms of the arrangement are realized, an extra 200,000 barrels of oil per day could enter the market throughout next year. But there are risks.

“Since the deal, the Supreme Court in Venezuela has already suspended the results of the opposition’s primaries. Clearly, the risk is that the United States will reimpose sanctions if the Venezuelan government does not stick to its side of the deal,” Mr. Patterson said.

Looking Ahead to 2024

Expectations for 2024 have become mixed as of late.

Following what was almost a certain worldwide supply deficit heading into 2024, there are now forecasts of a surplus, at least in the early days of the fresh calendar year.

ING strategists believe that the oil market will record a surplus in the first quarter of 2024, which could lower prices.

“However, the market is then set to tighten for the remainder of 2024, particularly over the second half, which suggests further upside to prices,” the ING research note reads.

“We currently forecast ICE Brent to average $90/bbl in 2024 and $95/bbl in the second half of 2024. However, the potential loss of Iranian barrels would leave the market in a deeper deficit and bring $100/bbl oil back into play.”

Supply conditions have created a cloudy forecasting climate.

Saudi Arabia and Russia recently expanded their production cuts through the end of 2023. Industry experts believe that these two energy powerhouses could extend their output reductions to kick off 2024.

Saudi Arabia targeted speculators for the latest selloff and hedge fund shorts, prompting observers to think that the kingdom could cut production to punish the shorts.

The other factor is that U.S. production touched an all-time high of 13.2 million barrels per day in October, topping the pre-pandemic high of 13.1 million. The Energy Information Administration (EIA) anticipates that this will be the standard output volume throughout 2024.

At the same time, some have questioned if this is sustainable based on slowing drilling activity over the past year.

The Baker Hughes Oil Rig Count dropped to 496 for the week that ended on Nov. 3, down from 504 in the previous week. This was the lowest reading since January 2022.

Energy markets are still “vulnerable,” and crude prices could be undervalued by at least $10, according to Phil Flynn, an energy strategist at The PRICE Futures Group.

“As hard as we fell, we could snap back in an instant because we had too many folks on one side of the boat,” Mr. Flynn said in an analyst note.

“That means the global economy is either facing the same fate as the Titanic or we could see a massive short-covering rally with just one headline.”

In the long term, oil prices could remain elevated, even as the global marketplace transitions to renewable energy, according to a Goldman Sachs analyst.

The paucity of certainty presented difficulties for energy firms, which might lead to routine shortfalls, said Daan Struyven, who leads oil research for Goldman Sachs.

“Because the demand outlook is so uncertain, companies are delaying their investments in expensive, long-cycle projects,” Mr. Struyven said.

“As existing projects get depleted, oil supply could drop—and rather than a surplus of oil, we may find ourselves with regular deficits.”

Even in an environment of shrinking crude consumption, oil prices “could remain remarkably robust.”

The Economy

A plethora of forecasts of slowing U.S. and global economies, fueled by recent comments from Federal Reserve Chair Jerome Powell, have further weighed on crude prices.

Speaking at an International Monetary Fund conference on Nov. 9, he warned that monetary policy might not be restrictive enough and that officials could raise interest rates if the economic data warranted hikes.

But the futures market still widely thinks that the Federal Open Market Committee is finished with rate hikes, according to the CME FedWatch Tool.

Investors are beginning to pencil in rate cuts as early as June 2024.

A chorus of economists and even a regional central bank head think the higher-for-long mantra embraced by the Fed could eventually break something.

Richmond Fed Bank President Tom Barkin thinks that the net effects of all of the institution’s tightening since March 2022 “will eventually hit the economy harder than it has.”

Looking ahead, Goldman Sachs predicts that the real gross domestic product (GDP) growth in the United States will be 2.1 percent in 2024 and 1.9 percent in 2025.

The global economy is anticipated to advance by 2.6 percent next year and 2.7 percent in 2025.

Despite the 4.9 percent expansion for the United States in the third quarter, upcoming forecasts aren’t predicting similar growth.

Both the Atlanta Fed GDPNow and New York Fed Nowcasting models suggest a GDP of about 2 percent in the fourth quarter.

Consumer sentiment is weakening as above-trend inflation persists and borrowing costs weigh on household budgets.

The University of Michigan’s Consumer Sentiment Index tumbled to a lower-than-expected 60.4 in November, down from 63.8 in October.

One-year-ahead inflation expectations also rose to 4.4 percent this month, up from 4.2 percent in October.

Whether this bearish view of the economy leads to shrinking energy consumption remains to be seen.

Gasoline demand is roughly the same as it was a year ago, with consumption at about 8.7 million barrels per day.

By comparison, in October 2019, gasoline consumption was close to 10 million barrels per day.

Next year, the EIA anticipated in its latest Short-Term Energy Outlook (STEO) a 1 percent drop in gasoline consumption, “which would result in the lowest per capita gasoline consumption in two decades.”

“An increase in remote work in the United States, improvements in the fuel efficiency of the U.S. vehicle fleet, high gasoline prices, and persistently high inflation have reduced per capita gasoline demand,” it reads.

Still, retail gasoline prices are expected to average $3.61 per gallon in 2024, and Brent crude prices are projected to be above $93 per barrel.