Oil Market Weakens, Prices Plummet Amidst Global Economic Concerns
The oil market is currently experiencing its weakest state since late June, with prices plummeting amid increasing global economic concerns. The significant retreat in front-month prices and calendar spreads since the end of September has reversed much of the remarkable increase witnessed over the previous three months. Interestingly, the retreat in prices and spreads for U.S. crude futures (NYMEX WTI) has been even more severe than that of Brent.
Various commentators have attributed this collapse to the rise in interest rates and a worsening outlook for the global economy, which in turn is cutting the outlook for crude consumption. In October, benchmark yields on 10-year U.S. Treasury notes reached a 16-year high as traders anticipated that the U.S. central bank would have to hold overnight interest rates higher for longer to combat persistent inflation. Furthermore, manufacturers in the United States, Europe, and China have all reported worsening business conditions in October, eroding some of the gradual improvement seen between June and September.
On the production side, U.S. crude and condensates output surpassed pre-pandemic records in August, contradicting expectations that it would start to decline in response to the fall in prices since mid-2022. However, the limited changes in production and consumption observed over the last two months cannot fully explain the speed and scale of the price and spread drop.
The sudden collapse in prices and spreads, following a period of significant increase, exhibits characteristics of a short-covering rally and a squeeze on deliverable supplies that has since unwound. Between the end of June and the end of September, total U.S. petroleum inventories, including the strategic reserve, rose by nearly 15 million barrels. However, commercial stocks of crude oil declined by 38 million barrels, and over 21 million barrels were depleted at Cushing in Oklahoma, which serves as the delivery point for the NYMEX WTI contract.
Despite holding less than 10% of all crude inventories at the end of June, Cushing accounted for 55% of the nationwide depletion. Other regions in the Midwest experienced small depletions of 5 million barrels, while the Gulf of Mexico witnessed an 8 million barrel decrease, with insignificant changes elsewhere. Interestingly, Cushing inventories depleted more consistently compared to the rest of the country, contributing to the near-record backwardation of the WTI futures contract by the end of September.
The drawdown in deliverable stocks has shown a close correlation with the increase in the nearby backwardation. In response to rising prices, hedge funds and other money managers were compelled to reduce bearish short positions in NYMEX WTI from 136 million barrels at the end of June to 20 million barrels by the end of September. Consequently, this enforced reduction of bearish short positions further accelerated and amplified the price increase, creating a self-sustaining rise in both spot prices and spreads. By the end of September, bullish long positions outnumbered bearish short positions by a ratio of 16:1, up from 2:1 in June.
However, prices and spreads have since collapsed, despite minimal changes in U.S. crude inventories at Cushing and elsewhere. Fund managers’ short positions have risen once again to 75 million barrels, and bullish longs now outnumber bearish shorts by a ratio of just 3:1. Throughout October and early November, the unwinding of short covering and the squeeze was masked by a sudden upsurge in violence in the Middle East and the associated risk of escalated conflict impacting crude oil production. As the risk of escalation diminishes, the unwinding has become more apparent and has amplified the downward pressure on nearby futures prices.
In reality, the market was never as tight as prices and spreads had suggested in late August and throughout September. The unwinding of the squeeze and the reduction of conflict premiums have brought the market back to a more neutral state. Currently, both Brent and WTI prices are nearly aligned with the average since the start of the century in real terms. The six-month spreads for both WTI and Brent remain slightly higher than the long-term average, indicating a residual strength resulting from crude inventories moderately below average for this time of year.
Overall, the market has returned to a neutral state, showing neither bullish nor bearish conditions compared to the strongly bullish conditions that prevailed in September. The production restraint by Saudi Arabia and its OPEC⁺ partners is being offset by continued growth in non-OPEC output and a downgraded outlook for global growth.
