Commodities Corner: Why oil prices just dropped to their lowest since July

On Tuesday, oil prices fell on the back of a slowdown in China’s oil demand, which has come not only because of lower than expected economic growth, but because of lower exports of petroleum products, said Anas Alhajji, an independent energy expert and managing partner at Energy Outlook Advisors.

China trade data show that the country imported 13.5% more crude in October than a year ago, according to news reports, but the year-ago figure was low due to coronavirus restrictions that were in place in 2022.

On its own, the crude-oil import data are bullish, but that is “not the case when we look at inventories, exports, and refinery runs,” said Alhajji. “Refinery throughputs are declining, inventories are rising, and exports are decreasing.”

In short, looking at the fourth quarter, Chinese data are becoming more “neutral than bullish,” he said, though a change in government policy can “return it to bullish.”

Exports have been declining because refineries ran out of government export quotas, Alhajji said.  Without additional quotas, or allowances, exports are expected to decline, resulting in “lower crude imports or higher inventories, or both,” he said.

China’s refinery utilization also declined in October as a result of “running out of quota and thin margins,” and refinery runs are expected to remain weak until trends are reversed, said Alhajji.  

On Tuesday, the December futures contract for U.S. benchmark West Texas Intermediate oil
CLZ23,
-4.44%

CL.1,
-4.44%
fell by $3.45, or 4.3%, to settle at $77.37 a barrel on the New York Mercantile Exchange. Global benchmark Brent crude saw its January contract
BRNF24,
-0.07%

BRN00,
-0.07%
fall $3.57, or 4.2%, to $81.61 a barrel on ICE Futures Europe.

Both WTI and Brent oil futures settled at their lowest since July 21, according to Dow Jones Market Data.

Global supplies

The EIA, meanwhile, in its monthly November Short-term Energy Outlook report released Tuesday, forecast growth in global oil production next year, but also said it expects ongoing cuts by the Organization of the Petroleum Exporting Countries and their allies, together known as OPEC+, to “keep global production growth lower than global consumption growth.”

The OPEC+ cuts are also likely to “contribute to inventory draws and upward oil price pressure” in the early part of 2024, the government agency said.

The voluntary production cuts from Saudi Arabia and ongoing output cuts from other OPEC+ countries raised OPEC’s spare oil production capacity to a forecast 4.3 million barrels a day in 2024, from 2.4 million barrels a day in 2022, the EIA said.

Heightened uncertainty around the recent the attacks on Israel, and the potential for tensions spreading to a wider area in the Middle East, “poses risk to oil supply, including available surplus production capacity,” it said. The EIA said it hasn’t materially changed its oil production forecast for countries in the Middle East, but also pointed out that the “geopolitical situation could change rapidly.”

U.S. output and demand

Over in the U.S., oil demand remains weak and lower than last year, while some European countries are “already in recession,” Alhajji said.

U.S. petroleum production has held ground at a record level for weeks, with output at 13.2 million barrels a day as of the week ended Oct. 27, according to weekly data from EIA.

The EIA’s monthly energy outlook report forecast 2023 U.S. oil output at an average of 12.9 million barrels a day, down 0.1% from the October forecast. It expects next year’s domestic output at 13.15 million barrels a day, up 0.2% from the previous forecast.

Read: U.S. oil production hits record as Israel-Hamas conflict stokes global supply fears

When it comes to demand for products refined from oil, the EIA said that next year, it expects U.S. motorists to consume less gasoline per capita, which would result in the lowest gasoline consumption in two decades, it said.

“U.S. motorists are driving less because they aren’t commuting to work every day, newer gasoline-fueled vehicles are more efficient, and there are more electric vehicles on the road,” EIA Administrator Joe DeCarolis said in a statement on the release of the energy outlook report. “Put those trends together with high gasoline prices and high inflation, and we find that U.S. motorists are using less gasoline.”

Troy Vincent, senior market analyst at DTN, however, said the bearishness in oil isn’t all about refined product demand weakness.

The bearishness has a lot to do with what “end of winter refined product balances could look like if we have an El Niño-inspired winter weather pattern that spares U.S. refiners from unplanned outages” like the ones they have suffered over the past two winters,” said Vincent.

That also implies far more refined product supply hitting the market, which should weigh on refining margins moving into the spring, he said.

Price risks

For now, the “reality” is that crude prices ran up nearly $10 a barrel on the back of a geopolitical crisis that “didn’t impact oil supply,” Vincent told MarketWatch.

While the risk of the war spreading and becoming a more widespread regional crisis that could have impacted oil supply was “real, it was also low,” he said. The U.S. administration has been “working tirelessly to make sure that didn’t happen.”

And following an “uneventful speech” by Hezbollah chief Hassan Nasrallah a few days ago, the geopolitical risk premium continued to fade,” said Vincent.

Now, the market is “getting back to staring down fundamentals and is seeing Russia push more oil onto the global market and Chinese appetite for crude rolling over as refining margins are dropping and refiners have exhausted their product export quotas,” he said.

While OPEC is likely to continue to extend their supply cuts into 2024, that should “now be assumed as the base case and likely offers little upside for prices,” said Vincent.

This means the market will enter 2024 “with a lower price than OPEC had anticipated, and a persistent large spare capacity buffer that limits upside risk in the event of some unforeseen supply disruption,” he said.