Oil: Financial Bears and Physical Bulls

Figure 1: Non Commercial Net Longs for WTI (000)

Source: Bloomberg/Continuum Economics 

Bears Demand Concerns

Financial market participants are have been selling oil, as part of the concerns on the global economy slowdown for 2023 and expectations that it will hit oil demand. CFTC Net longs from non-commercials are now the lowest in the last 5 years, as speculators sell oil futures (Figure 1). We certainly agree with the H1 2023 pessimism and we are forecast that the U.S. follows EZ into recession (here). Meanwhile, we see a weak H1 in China as well, as voluntary social distancing restricting economic activity in the face of a massive COVID wave (here). The problem is that the sentiment in the physical market is not so bearish near-term and expectations remain of a tight oil market in H2 2023.

Physical market participants are also focused on supply.Firstly, the EU seaborne ban on Russian oil is estimated to take 1mln barrel per day and could remain a drag on net supply into H2 2023. Secondly, OPEC+ is determined to avoid a major oil price fall and are unlikely to quickly reverse the late 2022 production cuts and if prices go too low then further production quota cuts could be seen. Thirdly, major DM economies sales of oil from strategic reserves has largely been complete and the U.S. is planning long-term to rebuild the strategic petroleum reserve. U.S. shale has picked up production, but the responsiveness to high oil prices is less than it was 10 years ago due to a focus on profitability, while elsewhere the non OPEC new supply pipeline is small due to years of underinvestment with concerns over climate change. Additionally, the physical oil market is also looking at demand from a sector viewpoint, as well as a big picture macro perspective. Jet fuel demand was already expected to boost crude oil demand by 1-2mln b/d, as airlines return to normal schedules and this look more likely in H2 once the China COVID wave is over and travel around and from China surges.

The near-term outlook for oil prices is dominated by demand concerns and financial market pessimism could see a spike down to $70 and potentially as low as $65 – our technical analysts have this call in their quarterly chart pack (here). However, the demand concerns are likely to be tempered as the year progress and the physical market players will likely view anything in the low $70, as a structural buying opportunity. As supply tightening through 2023, the physical market could come to dominate, especially as the financial market will eventually be looking at U.S. economic recovery in H2 2023.

Overall, we see actual demand not worsening that much further but production will slow into 2023 and this should underpin oil prices in H1 before a recovery is seen in oil prices during H2 2023. We see WTI oil prices at $90 end 2023 and for end 2024 we see WTI oil prices at $95.For our Gold and Copper forecasts see the Commodity chapter in the Outlook (here).