TOCOM Energy

Risk-off sentiment persists in oil markets

Wu Hai

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February 7, 2023 5 min read

Crude oil futures were trading lower on Friday as a sell-off took losses for the week to more than 7%, despite gains earlier in the session as US inventory builds. A rebound in the dollar index also weighed on oil prices.

The US lifted interest rates by 25 basis points while both the European Central Bank and Bank of England followed up on Thursday with 50-point increases. Followed by the rate rise, the strong US jobs report sent the US dollar sharply higher, at the same time, U.S. industrial-linked factory orders dipped. It was highlighting more slowing in the economy, particularly on the industrial side, which is a negative for petroleum especially diesel demand.

Adding to the weaker sentiment, EIA reported a drop of implied demand for distillate fuel oil which is mostly diesel for the week to January 27. Distillate stocks in the United States are lower than usual but have been ramping up recently after dropping to close to critical levels late last year. A decline in consumption driven by lower industrial activity helped.There was also a crude oil inventory build of 4.1 million barrels for the week. This compared with a modest inventory increase of half a million barrels for the previous week.

There was slightly better news from China, with services activity bouncing back into expansionary territory during January, as both supply and demand picked up after the country took a U-turn on its zero-Covid policy.However, Investors have become less confident in the strength of the outlook, the crude demand outlook needs a clear sign that China’s reopening will be smooth and that the US economic growth momentum does not deteriorate quickly.

Helping to keep oil from moving further lower might be the European Union ban on Russian refined products set to take effect on Feb. 5, potentially dealing a blow to global supply. The G7 and Australia announced Feb. 3 that consensus had been reached on price cap levels for Russian-origin refined oil products ahead of new sanctions kicking in to ban EU countries from importing seaborne Russian petroleum products.

Under the new agreement, the group will impose price caps of $100/b on imports of Russian products that typically trade at a premium to crude, such as diesel, kerosene and gasoline, and $45/b on products like fuel oil that generally trade at a discount to crude. The regulations will take effect with a 55-day grace period for refined products loaded before Feb. 5 and unloaded by April 1. The futures market expects a calm transition as it had already priced in any immediate disruptions.
Market traders, however, have warned that shipping logistics could prove more challenging as refined products that generally travel in smaller tankers search for fleet capacity. Expectations are that the embargo will tighten the supply of fuels even though European buyers stocked up as much Russian diesel as they could get their hands on in the past few months.
On the product market, middle distillate cracks fell in all regions, with diesel registering more substantial losses than kerosene due to higher refining activity and a slowdown in demand. Jet has proved the most resilient among refined products last week, the price of jet fuel traded above diesel in Asia for the first time since 2020 with China’s emergence from zero-Covid expected to boost air travel demand.

Dubai’s discount to Brent narrowed in an indication of strength for the medium sour complex, with the April Brent/Dubai EFS spread tightening to $4.13/b Friday.
Intermonth spreads of JPX Dubai sank after holding steady during the previous week, while the front end of NYMEX WTI forward curve flipped into a deeper contango structure. M1/M3 spread of ICE Brent rallied on Friday but still traded lower on a weekly basis. As recent risk-off sentiment persists in markets, we will probably see a rebound in market structure and price premium for physical crude before the outright price climb again.