Why we could see a bigger short-covering rally in oil

Over the past two weeks, oil markets have been buffeted by a storm of top-down macroeconomic fears that have fueled momentum-tracking algorithms, resulting in a prolonged decline in oil prices, exacerbated by a final stage of range-hedging to the banks. The overwhelming discounting among money managers has taken positions in crude oil and petroleum products to their most extreme since the start of the global financial crisis (GFC) in 2008.

As expected, a big oil price selloff ensued: Brent from the first month crashed to $68.68 per barrel (bbl) intraday on September 10, the lowest price since December 2, 2021. While oil prices have recovered about $5/bbl in the week since, commodity analysts from at Standard Chartered pointed out that this is limited upside given the extremes of speculative positioning and warrants a larger short-covering rally.

Regarding the short-term trajectory of oil prices, StanChart recognized that getting a clear short-term directional signal from the fundamentals is almost impossible in such a volatile market, the SCORPIO group’s machine learning tool was recently blown away and producing quite inaccurate oil. price forecasts. However, StanChart points to some key bullish factors.

First, there is no oversupply, with September poised to become the tightest month of the year due to seasonal strength in demand and supply disruptions in Libya as well as the US Gulf. StanChart predicted that Libyan oil may take longer than expected to return to the markets. Two weeks ago, oil prices fell after Libya’s former central bank governor suggested a deal with authorities in Tripoli and Benghazi that would restore full oil exports was imminent.

Related: Oil Prices Rise on Jumbo Fed Rate Cut

At the time, StanChart said the nuances of the negotiations were significantly more complicated than market commentary had suggested. Well, little substantial progress has been made after two rounds of negotiations, experts report Libyan crude oil exports recorded a speed of 550 kb/d, about half the pre-crisis level of about 1.2 million barrels per day (mb/d). StanChart sees the output cut taking much longer than the market currently expects, suggesting the market has gotten ahead of itself in pricing in the immediate resolution of a de facto unresolved crisis.

Second, no supply surplus is likely in at least Q4-2024 and H1-2025 if OPEC+ producers stick to their commitments. Last week, StanChart reported that oil markets are overlooking the imminent removal of even more barrels from the markets in the coming months. In July, Russia, Iraq and Kazakhstan submitted their compensation plans to the OPEC Secretariat for overproduced crude volumes in the first six months of 2024. According to OPEC, all overproduced volumes will be fully compensated over the next 15 months until September 2025, with Russia “paying back” a cumulative amount of 480 kb. /d, Iraq 1,184 kb/d and Kazakhstan 620 kb/d.

According to StanChart, offsetting production cuts by the three OPEC members amount to a combined cut of 370 kb/d in October and then an amount ranging between 162 kb/d and 206 kb/d for November 2024 to September 2025. StanChart determined that the addition of the compensation program to the recently announced reduction in targets due to the delay in the implementation of the phase-down will lead to a drop in OPEC production by 530 kb/d in Q4-2024; 540 kb/d lower in Q1 and Q2-2025 and 560 kb/d lower in Q3-2025 if all commitments are kept.

StanChart argued that the current market assumption that there will be no offset cut is wrong because other OPEC+ countries are highly unlikely to take it lightly. StanChart says Saudi Arabia in particular is unlikely to accept any further backtracking on promises made by overproducers, noting that high-profile visits to Iraq and Kazakhstan by OPEC Secretary General Haitham al Ghais suggest OPEC plans to continue cuts promised.

“We have received strong assurances that Iraq remains fully committed to the DoC’s ongoing market stabilization efforts. During this visit, Iraq presented clear and decisive steps to offset the overproduced volumes and gave assurances that it will achieve full compliance in the future, ” al Ghais said after visiting Baghdad.

In another upbeat catalyst, the latest weekly data by the US Energy Information Administration (EIA) reveals that crude oil inventories at the WTI price point in Cushing, Oklahoma fell for the fifth consecutive week and ninth week in the past 10. Crude oil inventories fell 1.7 mb w/w at 10- monthly minimum of 24.69 mb, and now they are 11.25 mb below the five-year average.

By Alex Kimani for Oilprice.com

More top reads from Oilprice.com