To The Moon

Oil prices could find support soon 

I noticed that pump prices had fallen when I pumped petrol today. That brought a smile to my face.

Pump prices have fallen for the second time in a week, with major oil retailers such as Esso lowering rates last Friday. Now, a 95-octane grade cost around $2.76 a litre, a drop of 14% from its June high this year.

Although I was happy at the lower pump prices, the capital markets have been less than delighted with the lower crude oil prices.

Let me explain more below:

• Steep Decline in Crude Oil Prices
• US vs OPEC+
• Near-term support for oil prices

Steep Decline in Crude Oil Prices

Crude oil prices, represented by WTI prices, were hammered 7.1% last week to end at $78.74. This is the longest stretch of weekly losses this year.

The key reasons for decline in oil prices are strong US Dollar and concerns of an economic recession.

The US Fed is hawkish and plans to increase interest rates higher for a longer time. This has strengthened the US dollar. Higher US dollar means that oil will be more expensive (in US dollar terms) for non-US investors. This has resulted in a decline in oil prices.

Another reason for the drop in oil prices is concerns on economic slowdown. The US yield curve has inverted, with the short-term yields above the longer-term yields. This is a strong indication that that a recession could be coming, and this will hurt oil demand.

US vs OPEC+

Oil supply has been caught in a tussle between the US and OPEC+.

In an unprecedented coordination, the US President has ordered a release of 50 million oil reserves together with China, Japan, India and South Korea and the UK in December last year.

This fight against high oil prices were taken a step further in March this year when the US announced a release of 1 million barrels of oil per day from its reserve. This historic release will continue until the end of October 2022.

On the other hand, OPEC+ prefers oil prices to stop declining.

For the first time in more than a year, OPEC+ agreed to a cut in production of 100,000 barrels per day (bpd) in a meeting on 5th September. They also agreed that OPEC's leader Saudi Arabia could call an extraordinary meeting anytime to provide a support to oil prices.

With the steep decline in oil prices, such extraordinary meeting could be coming soon. In fact, just two days ago, Nigeria’s Oil Minister Timipre Sylva remarked that the OPEC+ may be “forced” to cut output if oil prices continue to fall.

Near-term support for oil prices

At current prices of $78.7, oil prices have crashed 36% from its high in June this year.

With the crash in oil prices, the US is winning in the supply fight to keep oil prices down.

But the US could be running out of ammo to outlast the fight. Its strategic oil reserve is at historically low levels – 427.2 million of barrels. This is almost 29% decline from 600 million at the beginning of the year. In fact, there are rumours that the US could refill its reserve when crude prices dip to below $80.

Oil inventories are also "critically low" in a warning by the International Energy Agency's (IEA). This is driven by declining spare capacity and reduced OPEC+ production.

Lastly, on the demand side, there could come a catalyst from China. With Chinese President Xi Jinping travelling overseas, this is a sign that China could shifts its policy away from Zero-COVID. This will boost the China economy and raise the demand for oil.

In early January, oil prices hit a low of $74.3. That could be how low oil prices could go if the supply and demand factors turn favourable for oil prices.