Nov 13 / Victor Arduin

Energy Weekly Report - 2023 11 13

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"With more oil entering the market, prices are finding little room to sustain themselves at current levels. Iraq is producing more oil than it had in the past five years, and Venezuela has received relief from Western sanctions, which should allow it to increase production in the long term."

The price structure of oil undergoes a radical change

  • Crude oil inventories may have risen by over 12 million barrels in the week ending November 3rd if the projections from the American Petroleum Institute are confirmed.
  • The market is swiftly transitioning from a backwardation structure to contango, exerting additional pressure on the upcoming OPEC meeting to take supportive measures for prices.
  • The international context poses challenges to the demand for energy commodities, with weak economic data in Europe and China, and demand in the United States falling below expectations.

Introduction

The macroeconomic context has been one of the main bearish factors for energy commodities in 2023. High interest rates in major world economies, impacting consumption and investment, along with the appreciation of the dollar, are factors likely to affect the demand for energy from fossil fuels.

Indeed, the first half of 2023 was quite bearish for oil, with the price of the barrel accumulating losses until mid-year. This trend was only reversed after announcements of measures by OPEC+, led by Saudi Arabia and Russia, who declared supply restrictions.

Furthermore, during the second half of 2023, the conflict between Hamas and Israel introduced a new component of volatility that raised concerns in the market. Although both countries are not major oil producers, the fear that the escalation of the war could somehow involve Iran brought risks to global supply.

However, the scenario has changed rapidly. Since the highs recorded in September, major benchmarks have retreated substantially, a movement that was accentuated by the dovish signals from US monetary policy, which theoretically should provide more room for energy commodities to appreciate.

In this scenario, OPEC+ actions to support oil prices will be crucial. The group meets on November 26, with expectations that further measures will be announced to stabilize prices.

Image 1: OPEC Production vs. Major Crude Oil Benchmarks

Source: Refinitiv

The reversal of the bearish market sentiment will depend on the measures announced by OPEC+

Oil prices continue to be under pressure due to a combination of factors, including weak economic data from China, recession risks in Europe, and lower-than-expected demand in the United States. API projections foreseeing an increase of approximately 12 million barrels in U.S. inventories, reinforce a bearish sentiment for major oil benchmarks.

Amid a more challenging scenario for oil producers, market attention is now focused on OPEC+ countries, who convene on November 26. The additional measures to be announced are expected to provide more support to prices, which have incurred losses in the month of November.

Image 2: OPEC-13 Production (Millions bpd)

Source: OPEC

The alliance of oil-exporting countries has aggressively reduced its production quotas since July to support prices. However, even with the escalation of the conflict between Hamas and Israel, an additional volatility factor that tends to boost prices, the market has declined in recent weeks due to weak economic indicators - especially in China - and a robust supply of oil from non-OPEC+ countries.

With more oil entering the market, prices are finding little room to sustain themselves at current levels. Iraq is producing more oil than it had in the past five years, and Venezuela has received relief from Western sanctions, which should allow it to increase production in the long term.

In a scenario of economic growth, the production increase might not be sufficient to meet demand. However, with economies facing challenges, the market may be in a much smaller deficit than it was thought a couple of months ago.

Image 3: Spread of WTI Futures Contracts (spread in dollars)

Source: Refinitiv

In Summary

The energy complex finds itself in a situation that deviates significantly from what one might have anticipated last month, particularly following the recent conflict between Hamas and Israel. Weak economic data from China raises doubts about the country's future imports, while Europe may enter a recession next quarter.

Additionally, if the projections from the American Petroleum Institute are confirmed, the U.S. is expected to register the largest build in crude oil inventories since February of 2023.

Without additional measures from OPEC+, prices are unlikely to stay at the current level. However, OPEC+ also faces the challenge of reconciling the interests of various countries, which are not always convergent.

An example of this is Iraq, which has increased its oil production beyond the agreed quota. This reduces the supply deficit globally, theoretically undermining the efficiency of the group's strategy.

The rapid transition of the price structure of futures contracts for major benchmarks to a contango structure indicates that the market is increasingly taking a more bearish view on oil, despite the risks present in the current situation.

Weekly Report — Energy

Written by Victor Arduin
[email protected]
Reviewed by Alef Dias
[email protected]
www.hedgepointglobal.com

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