Paisie: Economics Edge Out Geopolitics

The price of Brent crude failed to break above $80 during December and the first half of January, while the price of WTI failed to move above $75 and some change.

The oil market has continued to discount the geopolitical risks, even though the Israel-Hamas conflict is widening with the involvement of the Houthis, who are disrupting maritime traffic through the Red Sea. Furthermore, the threat of increased involvement of Hezbollah remains.

Instead of the geopolitical risks, the oil market remains more concerned about the economic outlook conditions and oil demand.

• While the headline number associated with the recent U.S. jobs report exceeded market expectations, the report has some underlying signs of weakness: labor force participation remains low at 62.5%, with 683,000 workers falling out of the labor force in December; a record high of 8.69 million workers are holding multiple jobs; since June, 1.5 million full-time jobs have been eliminated, while 796,000 part-time jobs have been created.
• The latest Purchasing Managers’ Index reports from the Institute for Supply Management (ISM) also indicate weakness in the U.S. economy. The ISM services PMI for December decreased to 50.6 from 52.7 in November. The ISM manufacturing PMI for December increased to 47.4 from 46.7 in November: however, the index has remained below 50 (which reflects contraction) for 14 consecutive months.
• The manufacturing sector in the Eurozone also remains under pressure with manufacturing activity contracting for 18 consecutive months. There are concerns about inflation accelerating again with the initial estimate for the Consumer Price Index in the Eurozone for December reaching 2.9%, in comparison to 2.4% in November. Increases in the costs of food and services offset the moderate decrease in energy costs.
• Early in January, the World Bank issued its forecast for China’s economic growth for 2024 (4.5%) and 2025 (4.3%), which compares to 5.2% in 2023. China’s economy continues to be hampered by its real estate sector, where investment has decreased by 18% during the last two years and a limited recovery in consumer spending.

Additionally, like Europe, there is the growing realization that the Federal Reserve in the U.S. is likely to be keeping interest rates higher for longer than the optimistic view held at the end of last year. The inflation rate (excluding energy and food) is remaining well above the 2% targets and in recent months has stopped declining.

Besides the concern about the growth in oil demand, the oil markets are not convinced that OPEC+ will move forward with the additional cuts announced at its Nov. 30 meeting.

OPEC+ agreed to reduce its oil production by an additional 700,000 bbl/d—which will come from Iraq, UAE, Kuwait, Kazakhstan, Algeria and Oman. Saudi Arabia also agreed to extend its voluntary cut of 1 MMbbl/d, and Russia agreed to reduce its exports of refined products by 200,000 bbl/d beyond its current reduction of 300,000 bbl/d.

The additional production cuts were slated to start at the beginning of 2024. But there are fears of additional supplies from Iran and Venezuela. Iranian oil exports have increased to around 1.5 MMbbl/d, with rising Iranian production approaching 3.2 MMbbl/d. Venezuela was able to increase its oil exports to roughly 700,000 bbl/d in 2023, which is an increase of more than 10% in comparison to 2022. The U.S. is taking about 20% of Venezuela’s exports and China is buying 65%. Venezuela aims to increase production above 1 MMbbl/d, but production increases will be dependent on the extension of the U.S. license beyond April, along with the allowance to continue importing condensate from Iran.

Consequently, the sentiment of oil traders continues to be negative. The net long position of WTI traders remains at a depressed level and near the level seen in July 2023 before the announcement of the voluntary cut of 1 MMbbl/d by Saudi Arabia. Since late September, WTI traders have reduced their net long positions by more than 70%. Traders of Brent have also been reducing their net long positions with short positions increasing significantly.

The traders’ sentiments could become more positive with verification that OPEC+ is following through with the additional supply cuts. Another development that could support of higher oil prices would be the U.S. reimposing tighter sanctions on Iranian oil exports. Any increased sanctions would place the U.S. in starker opposition not just to Iran, but also to China, which imported 1.2 MMbbl/d of Iranian crude in December.

The full impact of these developments, however, will take time. We are expecting the oil markets to continue discounting the geopolitical risks unless there is a material impact on oil flows. Without such an impact on volumes, we expect that, during first-quarter 2024, oil prices will bounce upward with any negative geopolitical news. But any price increase will quickly fade once the markets see that oil is still flowing.