Crude Oil Prices Hover At High Levels, Easy To Rise and Hard To Fall

With US inflation rising beyond expectations, expectations of a Fed rate hike growing, and global capital markets generally falling, crude oil prices have remained firm, with the core reason still being market concerns about tightening supply. ?

At present, the EU has landed the sanctions on Russia crude oil. There is still uncertainty about how this would evolve in the later period, OPEC's ability to increase production is limited and supply of refined oil products is tight in the summer. These contradictions are still difficult to ease in the short term. China's easing of covid-19 restrictions further boosted market sentiment, while civil unrest erupted again in Libya and crude oil remained intact in a strong pattern.

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I.Supply side inelasticity remains long term

OPEC has limited capacity to increase production. On June 2, at the OPEC + meeting, it was decided to increase crude oil production by 648 thousand barrels/day in July and August 2022, exceeding market expectations. OPEC + achieved its target of increasing production by August, originally scheduled for September, and cumulatively increased production by 1.73 million bpd over the first half of the year. According to the resolution, Saudi Arabia will add 114 thousand bpd, 170 thousand bpd and 170 thousand bpd per month over the next 3 months; the UAE will add 35 thousand bpd, 52 thousand bpd and 52 thousand bpd per month over the next 3 months. As of May, Rystad Energy's data showed global crude oil spare capacity of 8 million 138 thousand bpd, with current excess capacity concentrated in Saudi Arabia, Iraq, the UAE, and Iran, while other countries remain largely at full capacity, and OPEC + production plans to rise to 648 thousand bpd, still struggling to reach planned levels.

The EU imposed an embargo on crude oil. After a month of wrangling, the EU officially approved a sixth round of sanctions against Russia, including a phased oil embargo, which came into force on 3 June. The EU will also ban European insurers from underwriting Russian crude oil shipments, a step that will be phased in over the next 6 months, weakening Russia's efforts to sell oil in Asia. EU officials say the core of the sixth round of sanctions is the Russian oil embargo. Under these measures, the EU will gradually ban crude oil and refined fuels arriving in Russia by ship, which account for at least 2/3 of EU imports from Russia. But Hungary, Slovakia, and the Czech Republic, the neighbouring landlocked EU member states, have been granted broad exemptions from the oil embargo. Later, the main concern was whether Chinese and Indian crude oil imports to Russia would grow.

The US eased sanctions on Venezuela, Iranian crude oil was difficult to return in the short term, and civil unrest in Libya continued to underpin oil prices overall. The US loosened controls on Venezuela to allow more of the country's crude oil to enter Europe, while restoring Chevron's license to operate oil in Venezuela, adding about 200 thousand barrels/day to supply, however, it has played a limited role in easing the tight crude oil supply. On the Iranian side, Iran removed two International Atomic Energy Agency surveillance cameras from its uranium enrichment facility in early June. U.N. Monitoring, Verification and Inspection Commission adopted a resolution criticising Iran for failing to fully explain uranium traces at undeclared sites. The move has heightened tensions over Iran's nuclear negotiations, and US sanctions on Iran will continue, with short term Iranian crude still difficult to return. In mid-June, amid renewed civil unrest in Libya, the Libyan oil minister said protesters were calling for a shutdown of crude oil export ports due to internal political conflict, which currently produces around 100 thousand barrels per day. Libyan production fell to 760 thousand bpd in May 2022.

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II. Demand side struggles to meet expectations

Inflation soared, the US dollar appreciated, the economy glides down and demand for crude oil struggled to meet expectations. The inflation soared globally, with May CPI data from the United States rising to 8.6% year on year, outpacing expectations, refreshing the four decade high recorded in March, triggering market expectations that the Fed would continue to raise interest rates by 50 basis points, with some investors even betting that the Fed could hike rates by 75 basis points sharply if inflationary pressures did not cool. At the moment, the market is also betting on a stronger dollar, with the dollar index now exceeding the 105 mark and still showing an upward trend. Against this backdrop, tightening global credit easing remains a major trend. Looking at growth in the world's major economic regions, the US manufacturing PMI index rose 0.7% quarter on quarter to 56.1% in May, China’s PMI index rose 2.2% quarter on quarter to 49.6%, and the PMI in Eurozone fell 0.9% quarter on quarter to 54.6%. Demand for crude oil this year has struggled to meet expectations against the backdrop of declining global economic growth and soaring dollar indices.

The disruption to demand from covid-19 is still ongoing. For the time being, the impact of the epidemic on the demand side depends largely on the attitude of the government. For Western countries adopt herd immunity policy, the impact of the epidemic on demand is limited, but it remains the same for China, which zero-tolerance policy is used. The easing of covid-19 restrictions in China related should have further boosted market sentiment. However, a recent surge in cases in Beijing and Shanghai has led the authorities to tighten restrictions again. China's zero coronavirus policy remains a downside risk to the market.

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III. Crude oil stocks remain low and prices are hard to fall

At the moment, even as the US continues to release strategic reserves, it will be difficult to stop the decline in commercial stocks of crude oil, which currently stand at 416 million barrels, a record low for the same period since 2015. Strategic inventories fell to 519 million barrels, the lowest level since 1987. This round of strategic inventory is scheduled to release 180 million barrels for a period of 6 months, when the strategic reserve will be close to the safety line and enter the replenishment cycle later.

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Overall, the supply side of the tightness is still difficult to ease, oil prices are easy to rise but difficult to fall. Short term oil prices are expected to hover at high levels, but the overall volatility has moved up, with Brent Crude broadly in the range of $ 115-130 per barrel, suggesting to sell at high and buy at low.