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Commodities Week Ahead: After July, OPEC Will Fight to Keep Oil Up

By (Barani Krishnan)CommoditiesJul 31, 2023 10:03
Commodities Week Ahead: After July, OPEC Will Fight to Keep Oil Up
By (Barani Krishnan)   |  Jul 31, 2023 10:03
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  • Keeping the oil rally going will be OPEC’s challenge as Fed warily watches inflation
  • Fed will likely go back to aggressive rate hikes if inflation spikes from pricier oil
  • Higher inflation could hurt U.S. growth, ultimately hurting oil demand

Scoring the biggest gain for oil in 18 months is one thing; keeping it going is another. That’s what OPEC will attempt this week as the world’s biggest crude producers sit again to strategize how to manipulate the market their way, as top importer China continues to show signs of economic weakness.

With U.S. West Texas Intermediate, or WTI, hovering at $80 per barrel at the time of writing — and Brent at $84 — crude futures were poised to deliver an average return of 13% in July for longs in the game, after five straight weeks of gains. That was the largest monthly win for the two crude benchmarks since January 2022, when they rose by an average 17%.

But OPEC, or the Organization of the Petroleum Exporting Countries, has more on its hands as August dawns amid extended worries about demand out of China.

Data on Monday showed that Chinese manufacturing activity shrank for a fourth straight month in July, while broader business activity also deteriorated as oil’s biggest buyer struggled with a slowing post-COVID economic recovery.

How well the Federal Reserve does in keeping a lid on inflation will also matter to the 13-member Saudi-led OPEC and its extended OPEC+ group that includes 10 other oil-producing allies steered by Russia.

From a four-decade high of 9% in June 2022, the Fed has managed to bring inflation, measured by the Consumer Price Index, to just 3% per annum in June this year. But the success came with a big price: The raising of interest rates by 525 basis points in just 18 months to smother the runaway inflation caused by the trillions of dollars of pandemic relief spending by the government.

To keep inflation down, the Fed needs to keep a lid on U.S. jobs and wage growth. On Friday, the central bank will see how effective its high-rate regime has been in moderating these when the jobs report for July is published.

Economists are forecasting growth of 200,000 nonfarm payrolls on the average for last month versus June’s 209,000. The June figure was particularly an important one for the Fed as it came below economists’ estimates for the first time in 16 months, signaling progress in the Fed’s bid inflation-fighting efforts.

OPEC+, interestingly, will be meeting on Friday, too, just ahead of the release of the U.S. jobs numbers.

OPEC Only Cares About Adding to Oil Prices

The oil cartel, of course, doesn’t give a rodent’s rear as to whether the Fed succeeds in delivering lower inflation to Americans. Under new Saudi-led thinking, enabled by its Russian and Chinese allies, OPEC would just be as happy if the central bank fails and the American economy goes to the dogs.

All that matters to OPEC+ is that it gets to sell its oil at the highest possible price to the world, under the disguised term of achieving “market balance.” Until July, that aspired price was a minimum of $80 a barrel. Now, it’s back to $100 and above — its long-term target.

Be that as it may, OPEC cannot entirely ignore the inflation problem in the United States — regardless of how much Saudi Crown Prince Mohamed bin Salman despises President Joe Biden, and vice-versa. Inflation isn’t just caused by the happy spending of Americans from record jobs and wage growth.

It is also egged on by higher oil prices. If the crude rally from July continues without a loss of momentum, U.S. manufacturers and service producers are likely to go back to raising the costs of goods and services in America.

It wasn't always like this. A decade ago, oil was at $100 a barrel or around there. Then U.S. inflation was at a perma low of 2% or less as service and goods producers strove to keep costs low and consumers happy. The pandemic, however, changed everything.

Faced with supply disruptions and higher material costs in almost everything, U.S. businesses began charging more — and developed a liking for it when consumers paid without resistance. A new era of inflation was thus born.

Now, if oil goes back to $100, it will pull up inflation appreciably — not like before.

If inflation spikes again, we know what the Fed will do: Pile on interest rates, which have already ballooned by 525 basis points from a mere 25 in March 2022. If another full point gets added to U.S. rates from energy-related and other inflation, that couldn’t be too good for the economy — or the oil demand that rides on U.S. growth.

And with China in the doldrums, U.S. economic performance matters to the outlook of oil, regardless of what His Royal Highness Mohammed bin Salman thinks.

And while oil bulls are counting on OPEC+ amping up its mantra on production cuts at this week’s meeting of the cartel, what the U.S. government reveals on weekly domestic inventories might be just as important.

Since the Saudis announced they would take an additional million barrels per day off their production in July — on top of other cuts by the broader OPEC+ group — crude draws reported on Wednesdays by the U.S. Energy Information Administration, or EIA, has been modest, to say the least.

While no one expects a barrel-for-barrel correlation between changes in Saudi exports and U.S. crude balances, the weekly EIA reports should start showing sharper stockpile drops if the narrative of the super tight market for oil is to hold up.

According to regional data from Middle Eastern-based JODI, Saudi exports fell below 7 million barrels a day in May. If true, that would be a first in a long time for a country that for years rolled out between 9 million and 10 million barrels daily.

Due to its unparalleled disclosures and transparency, the EIA’s numbers matter more for oil market optics sometimes than data released by any peer agency. With just a week’s data unreported for July, the EIA’s numbers show U.S. crude inventories in a net build of 4.638M barrels in the first three weeks of the month.

John Kilduff, partner at New York energy hedge Again Capital said,

“I agree that just two or three weeks of data isn’t indicative of much, but I’d be very surprised if the EIA reports another anemic number for crude draws in the coming week or, worse, a build,”

“We have a near 15% rally in the flat price of oil for this month because the market has given the benefit of doubt to the production pledges made by OPEC,” adds Kilduff. “If the U.S. supply situation somehow escapes the dire consequences of these OPEC actions, then we might have a replay of what we saw earlier this year with oil prices: Fast and furious on the way up, then down.”

Those who are long oil, however, say there’s little chance of the market retreating easily this time. In May, for instance, when U.S. crude tumbled from $80 per barrel the prior month to beneath $65, the Biden administration was adding about three million barrels to supply each week from the Strategic Petroleum Reserve. Releases from the emergency oil reserve stopped two weeks ago.

Notwithstanding the net U.S. crude build over the past three weeks, supplies are 7% below the five-year average, says Phil Flynn, an avowed oil bull and analyst with the Price Futures Group in Chicago.

“Based on current demand levels, (supplies) are at their tightest levels in over a year,” he wrote earlier this week.

What’s more, oil bulls argue, is that Wall Street miscalculated the resilience of the U.S. economy, with preliminary data showing a year-on-year growth of 2.4% in the second quarter versus forecasts for an expansion of just 1.8%.

That growth number suggests the United States may dodge a recession altogether, they say. In fact, that’s what the Fed has also concluded, saying its economists have stopped pricing in a recession in their forecasts.

Flynn also says total petroleum product demand in the United States increased by 1.1 million barrels per day last week to a new peak of 32 million barrels a day. And continued declines in U.S. oil rigs mean production will only decline, he added.

But U.S. Energy Demand Modest Thus Far for Summer

Even so, demand for both crude and fuels has been underwhelming this summer.

The EIA reported a gasoline inventory draw of just 0.786 million barrels last week, versus a forecast decline of 1.678 million barrels and the previous week’s drop of 1.066 million. Automotive fuel gasoline is the No. 1 U.S. fuel product.

Finished motor gasoline products delivered to the marketplace — an indication of demand at the pump — stood at 8.855 million barrels versus the prior week’s 8.756 million. Typically, at this time of year, more than 9.0 million barrels of gasoline or more are supplied to the market each week.

In the case of distillate stockpiles, the EIA reported a draw of 0.245M barrels. Analysts had forecast a decline of 0.301M barrels last week, against a previous build of 0.014M. Distillates are refined into heating oil, diesel for trucks, buses, trains, and ships, and fuel for jets.

And for all the decline in rigs, which are down to 529 this week from a January peak of 623, U.S. oil production itself has held up admirably at above 12M daily as shale companies continuously add to production efficiency. The EIA estimated an output decline of just 0.1M barrels last week — a routine adjustment that barely changes anything.


Disclaimer: The content of this article is purely to educate and inform and does not in any way represent an inducement or recommendation to buy or sell any commodity or its related securities. The author Barani Krishnan does not hold a position in the commodities and securities he writes about. He typically uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables.

Commodities Week Ahead: After July, OPEC Will Fight to Keep Oil Up

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Commodities Week Ahead: After July, OPEC Will Fight to Keep Oil Up

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