TOCOM Energy

The US debt ceiling deal may provide only temporary relief to oil market.

Last week, Middle East benchmark Dubai crude prices rose for a second straight week, buoyed by lower inventories on both sides of the Atlantic basin and optimism over a potential agreement on the US debt ceiling deal. Crude oil futures Tuesday were sharply lower amid uncertainty on Congress waving through a debt ceiling deal, while a tension growing in the OPEC+ alliance also weighed.

Hopes were growing heading into the weekend as the White House and House Republicans have an agreement in principle on a deal to raise the debt ceiling for two years and cap spending. Despite a deal in principle, the final deal still faces a difficult path to pass through Congress before the government runs out of money to pay its debts in early June which is estimated to be 5 June. As debt limit predictions aren’t clear-cut, it is more of a best-guess estimate, which makes it harder to know exactly how much time Congress has to act to avert potential financial catastrophe. While few expect a first-ever default, a further debate is seen as damaging and will continue to roil markets before getting the bill over the finish line.

While there is going to be a temporary relief in the market, it does not address the impact of rising interest rates. In fact, it may also give more reason for the Fed to feel confident about trying to lift up rates again. Another development that could impact the decisions of Fed policymakers is the latest U.S. inflation data, which showed that the Personal Consumption Expenditures Price Index rose 4.4% during the 12 months through April, now the fed funds futures market has penciled in a 71% chance of a rate hike at the June Fed meeting, sharply higher than the 19% chance just a week ago, according to the CME FedWatch Tool. Conversely, if the fed does not raise interest rate at the next meeting, there’s a chance that commodity prices would rebound.

On the physical market, inventories data last week was bullish. US crude inventories saw their largest draw since last November, and oil product inventories dropped on both side of the Atlantic basin

However, refined product strength continues to be concentrated in consumer fuels like gasoline which saw crack spreads rise to their highest level since last July. Tight gasoline supply in the Atlantic basin, meanwhile, has pushed cracks higher globally.

The three-week rise in diesel margins however, skidded to a halt last week. The successful redirection of Russian supply and new streams in the US, China and the Middle East has resulted in ample supply, pushing the refining margin firmly back towards gasoline from April onwards.

The upcoming early June OPEC+ meeting is increasingly coming into focus, in particular a potential policy clash between Saudi Arabia and Russia. One of the talking points at the early-June OPEC+ gathering in Vienna is likely to be compliance levels, with Russian crude exports so far showing few signs that the announced cuts have been fully implemented. Asia’s imports of crude oil are on track for a strong rebound in May as the region’s two biggest buyers, China and India, suck up Russian cargoes.

As China and India buy more cheap Russian oil, Asian refiners has hold back middle east spot purchases. On the other hand, Middle Eastern petroleum exporters have gained overall from the Russia shock, mainly in the form of higher diesel prices. Annual term contracts with Asian refiners will also protect Middle Eastern exporters from Russian competition. Under the new trade route, their interests align with oil prices alone. So it’s estimated that Russia and Saudi Arabia will continue to cooperate closely on oil policy.