Commodities Monthly Update - June

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Balance POV

We see balance in EoS loosening as drop in demand outweighs supply against the backdrop of weak external demand and slow recovery. Balance in WoS has tightened with UK imports at seasonal high and Norwegian exports largely unchanged.

Supply

OPEC

AG exports dropped moderately (-419 kbd MoM), at a slower rate than last month. The downward trend is in line with the alleged production cut. And supply is expected to tighten further as the unilateral Saudi cut kicks in.

Russia

Russian exports fell marginally (-233 kbd MoM), attributing to the drastic fall in exports to South Asia (-567 kbd MoM). According to Kpler data, Russia has overtaken Saudi Arabia to become the largest exporter of oil to China. Nevertheless, supply from Russia is expected to tighten as Novak has announced a 500 kbd cut in export.

Iraq

Both Iraq and Turkey claim victory over the pipeline arbitration as the Tribunal has ordered Turkey to pay Iraq USD 1.5 billion and suspend the loading and export of crude oil through Iraq-Turkey pipeline. Turkey has now suspended transportation of crude, Turkish or Iraqi, halting the flow of 450 kbd.

Demand

UK

UK imports ticked up moderately (+212 kbd MoM), reaching a seasonal high. Increase in UK demand signaled resilience of the underlying economy and contributed to the tightening balance in the West of Suez.

China

China demand dropped mildly (-445 kbd MoM), still remaining at seasonal high. The elevated level of import despite slow recovery is likely attributed to stockpiling efforts. Korean exports fell drastically by 611 kbd MOM. In the East of Suez, reduction in demand outweighed drop in supply, leading to loosening balance.

West

Update on FOMC and impacts on price of WTI

The FOMC has been tackling record-high U.S inflation that peaked during the Covid-19 pandemic. To settle down price gains, the FOMC has been hiking interest rates, slowing economic growth and tightening the credit market gradually.

The FOMC decided to leave the federal funds target rate unchanged at a range of 5.0% - 5.25%. This June meeting marks the first policy meeting at which the FOMC has not raised interest rates since it began its monetary policy tightening cycle in March 2022.?

Fed Chair Jerome Powell was reluctant to describe this decision to hold rates steady as a “skip” during the FOMC Meeting. Powell’s hawkish stance on interest rates is that he doesn’t see a rate cut until inflation comes down significantly which would take a couple of years.

The FOMC is strongly committed to returning inflation to its 2% objective and hence the odds of a July hike are rather high.

With the expected Fed interest rate hike, tightening of monetary policy can be signaled. This could potentially dampen demand for oil, including WTI, which could put a downward pressure on prices.

With a raised interest rate by the Fed, U.S dollar can also be strengthened relative to other currencies. A stronger dollar can make oil more expensive for buyers using other currencies leading to lower demand and potentially lower WTI prices.

After the June FOMC Meeting where the Fed signaled more interest rate hikes ahead, WTI crude closed $1.15, or 1.7%, lower at $68.27.

Low crude oil and gasoline inventory amid bearish sentiment for gasoline?

In the final week of June, US commercial crude oil inventory slid by 2.408 million barrels, reaching below the 5 year average. The US strategic petroleum reserve sold another 1.4 million barrels, continuing to remain significantly below the 5 year average. The combined inventory of crude within the US poses a risk in the overall supply. However, crude oil production also fell back to 12.2 mb/d, reaching back to the previous low of the year. The cuts in inventory could be attributed to the overall OPEC+ cuts in production. In the next quarter, we expect greater inventory cuts in order to push prices upwards. Therefore, we are bearish on the price of WTI in the second half of 2023.?

Gasoline inventories also fell by 2.85 million barrels but still remaining higher than previously recorded lows in May. Demand for gasoline continues to remain weak, hovering below the 5 year average. This could be due to the increase in the number of electric vehicles within the US despite a supposed summer driving season. Electric vehicles make up 5.6% of the total US car market and we expect the uptake of electric vehicles to remain on an upward trend causing the potential total demand for gasoline to drop. As such, with the incoming end of summer driving season and the start of winter heating season, we remain bearish towards gasoline in the second half of 2023.

ECB and BOE rate hikes

The Bank of England surprised the market by raising its benchmark interest rate by 0.5% to combat the worst bout of high inflation since the 1980s. The move indicates that UK borrowing costs could continue to rise in contrast to the US Federal Reserve, which has paused its tightening measures. This decision poses challenges for borrowers, with warnings of a potential mortgage crisis as rates increase. Although the government supports the Bank of England's efforts to address inflation, calls to assist struggling borrowers have emerged. Bloomberg Economics predicts that if rates reach 6%, the UK could face a recession.

Similarly, the European Central Bank (ECB) has raised interest rates by a quarter-point, and another hike in July is highly likely. President Christine Lagarde emphasized the persistent high inflation in the eurozone, indicating the need for further action. Recent inflation readings have come in below estimates, but concerns remain about rising wages putting upward pressure on prices.

Based on the recent development where Brent crude futures settled down $1.92, or 2.6%, at $72.26 a barrel, coupled with the actions and statements from central banks, a bearish sentiment emerges for Brent prices. Higher interest rates can weigh on economic growth, which may lead to a decrease in oil consumption. Moreover, the concerns about a potential mortgage crisis and the risk of a recession in the UK add to the bearish outlook. The uncertainties surrounding economic growth and inflation in the eurozone, along with unease in the bond market, further contribute to the bearish sentiment. Overall, these factors indicate a cautious outlook for Brent prices in the near term.

East

OPEC exports fall slightly in June

After news of the unilateral 1 million bpd cut by Saudi Arabia, crude oil prices are lower today than they were prior to this announced cut, and are set to post a fourth straight quarterly loss. China’s weak economic recovery and expected rate hikes by the US weigh on sentiment, while robust crude exports from countries like Russia and Iran outweigh production cuts from OPEC.

Oil production from OPEC posted a small drop of 50,000 bpd in June, pumping a total of 28.18 million bpd. This figure shows that the group has little progress in limiting supply ahead of voluntary cuts by Saudi Arabia in July, as increases in Iraq and Nigeria limit the impact of cuts by other members. As Saudi’s s extra cuts go to effect in July, prices could tick up as supply tightens and the country is known for its high compliance to production cuts. However, the flood of cheap Russian oil has depressed prices, which would hurt Saudi’s ability to fund its economic program. This opens up the possibility of them prolonging their 1 million bpd cut after July.

Iran oil exports rising

Iran’s crude exports are quietly flooding back into the global market, with exports of more than 1.5 million bpd in May being the highest monthly rate since being sanctioned by the US in 2018. The rebounding sales illustrate the progress being made since the China-brokered Saudi-Iran Deal.

China remains Iran’s top buyer of its discounted barrels, but has to deepen the discount to compete with cheaper Russian crude. Therefore, even though the increasing influx of Iranian oil undermines efforts by OPEC, sanctions have limited its ability to make a substantial impact on oil prices.?

Crude Floater Build Up in Red Sea

There was a build up of around 20MBD of Saudi Arabian crude off Egypt’s Ain Sukhna port. Ship tracking data showed 10 floaters off the port, with 8 vessels being Saudi-owned. One possible explanation for the build up is the increase in European demand for Saudi Crude. Ain Sukhna serves as the Red Sea end point for the Sumed pipeline system, which leads to the Mediterranean terminal at Sidi Kerir. Since VLCCs (Very Large Crude Carriers) fully loaded are incapable of passing through the Suez Canal, they have the option to unload their cargoes at Ain Sukhna. These cargoes can then be picked up at Sidi Kerir for subsequent transport to Europe or the Americas.

Cyclone Biparjoy Hits India and Pakistan

India and Pakistan were hit by Cyclone Biparjoy this month, leading to the temporary closure of four major ports - Sikka, Mundra, Vadinar, and Karachi - from June 11th to 17th. This resulted in an estimated shortfall of approximately 10 million barrels in crude imports. The cyclone also disrupted product exports, compelling Reliance Industries to suspend diesel exports from the Sikka port. Notably, Reliance Industries is a significant exporter of diesel to Europe.

On the other hand, most refineries continued operations using their existing inventories. Therefore, while crude demand is likely to remain unchanged, the disruption may affect Europe's diesel supply.

Bearish PMI Numbers

The June PMI numbers paints a bearish picture for China with the Caixin Manufacturing PMI dropping from 50.9 in May to 50.5 in June and the NBS official Manufacturing PMI rising from 48.8 in May to 49.0 in June. Despite the slight rebound in manufacturing activity, the official Manufacturing PMI of 49.0 is still within the contraction range.

Elsewhere in the services subindex,? the NBS official services PMI fell to 52.8 in June from 53.8 in May. This was in spite of China’s 3-day Dragon Boat Festival holiday, which should have boosted the services PMI via tourism. These contractionary PMI numbers correspond with the weaker domestic demand faced by China, leading to a market-wide consensus that China’s economic recovery has been lackluster.

Muted Policy Impact paints Bearish H2

Speculators looking to government fiscal stimulus for relief may be setting up for disappointment. Towering levels of local government debt and already low interest rates forecast a muted fiscal policy impact on demand, and existing monetary stimulus has done little to stimulate loan demand. While the State Council has proposed measures to boost the consumption of household products, no further details on specific measures were divulged. Overall, government intervention looks to have limited impact on stimulating demand, painting a grim outlook for 2H2023.