Commodities Monthly Update - February 2023

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TLDR

~Development this month:

• US supply at seasonal high with weak demand
• OPEC production rose but still undershooting quota
• Russian crude export at seasonal high, effects of sanctions remain to be seen
• Crude export to China within seasonal range
• Brent prices rebounding to 85.23 on UAE’s threat to leave OPEC
• US unemployment claims fell by 3000 to 192,000
• Resilient labour market potentially forcing the Feds to raise interest rates beyond? the 5.1-5.4% projected by most Federal Reserve policy makers
• Russia plans cut in oil exports by up to 25%?
• China’s PMI rising to 52.6 from 50.2 in Jan 2023

Balance

Supply

US

US commercial crude inventory has been building up for 10 consecutive weeks. Domestic supply is at seasonal high whiledemand remains tepid at seasonal lows. The weak demand is attributed to refinery turnaround and contracting manufacturing activities. However, US crude export hit a record high of 2702 kbd in Feb, led by an increase of exports to the EU.

US oil drilling activity has declined since mid 2022, responding to the downturn in oil prices and uncertain outlook. The rig count is now at the lowest level since July 2022, and it translates into slower production growth throughout 2023 and into 2024.?

OPEC+?

Despite commitments to supporting the market, OPEC oil output has risen led by a rebound in Nigeria output. OPEC pumped 28.97 million bpd in Feb, up 150 kbd from Jan. Nigeria, troubled with oil theft and security issues, raised output by 100 kbd, which is the largest gain in the group. Despite the rise, member states are still undershooting their quota by about 880 kbd.

UAE’s Rumoured Exit

The UAE is once again rumoured to be considering leaving OPEC. Having had to agree to the output level set by OPEC, the UAE has been unable to produce as they deem fit. In tandem with the growing tensions building between Saudi Arabia and the UAE, it is no wonder such a turn of events have culminated in the current rumours. However, the UAE has come out refuting said claims, albeit after the spike in Brent prices to the current 85.23 level.

Nonetheless, such an exit will undoubtedly hurt OPEC’s ability to control oil prices, especially since this comes on the back of 2 prior departures in 4 years: Qatar in 2019 and Ecuador in 2020. Furthermore, since the UAE accounts for a sizeable 10% proportion of OPEC’s production, and they plan to further increase production should they withdraw from said cartel, it is likely oil prices will take a further hit, unless OPEC were to jointly decide on cutting production significantly.

Russia-Ukraine War Russian sanction

The sanctions enacted by the EU in early Feb were more stringent than earlier ones, but they didn’t seem to curb Russian crude exports by much. In fact, Russian crude export is at seasonal high. Refinery throughput in India has reached a record high of 5.39 million bpd, highest in Reuter record. India’s import of discounted crude from Russia has also hit the record. Whether and how much the sanctions will weigh on Russian crude remains to be seen in weeks to come.

Demand

China Overestimated

The PMI release rekindled optimism about China demand. The Caixin/ S&P Global services PMI rose to 55 from 52.9 in Jan. According to the Caixin survey, new export order growth accelerated to the highest in almost 4 years. Despite all the hype, China demand may be overestimated as world weekly export to China stays within the seasonal range. Also, the rebound in demand will likely take several months to manifest? after the lifting of zero-covid policy.

Macro

Fight Against Inflation

US’ Resilient Labour Market

As the number of Americans filing new claims for unemployment benefits decreases, the fear that the Feds may raise interest rates beyond the anticipated 5.1-5.4% range continues to grow. These worries were further amplified by other data, such as the personal consumptions expenditures (PCE) index. Excluding food and energy, core PCE rose at 4.3%, revised up 0.4 percentage points from the advance estimate given in mid Feb. Furthermore, personal income increased 388.1 billion last quarter, which was revised up 77.2 billion.

Such tightness in the labour market is sure to generate wage growth, in turn ensuring inflation remains elevated. In order to meaningfully tame inflation, more significant rate hikes, or rate hikes for extended durations need to be delivered, both of which will lead to heightened terminal interest rate levels. Currently, the market is expecting a terminal rate of 5.5%.

Further cuts to Russian Exports?

Russia has already announced plans to cut its oil production by 500kb/d, amounting to 5% of its daily oil production. However, further cuts up to 25% may happen, as they attempt to pull up their oil prices albeit the Western price caps imposed.

Currently, the bulk of their exports have gone the way of India, China and Turkey. However, this has led said respective countries to flood the markets with fuels produced from Russian oil, limiting their ability to sell additional oil.?

China’s rising PMI

China’s reopening has been one of the major tailwinds for oil prices in the past few weeks. With their purchasing managers’ index rising 2.5 points to 52.6 in Feb, and a private sector survey showing rising activity for the first time in 7 months, the rise in oil prices is inevitable to fuel such growth.

Nonetheless, while manufacturing activity? is a powerful demand driver, the extent to which China can influence oil prices is also highly dependent on countries importing Chinese goods. In this inflationary environment with seemingly unceasing rate hikes, the average global consumer’s purchasing power is severely limited. This may dampen China’s recovery in the near future, in turn pulling down oil prices.