TOCOM Energy

Crude oil futures experienced a volatile week, with prices swaying due to the uncertain evolution of geopolitical tensions and shifts in supply and demand metrics.

Oil prices climbed about 3% to a one-week high on Friday after Israel’s military widened its ground attacks on the Gaza Strip, whether the conflict remains limited to a confrontation between Hamas and Israel or escalates into a broader regional conflict still remain uncertain.

History shows that these conflicts often impact prices in the short term, but do not typically overwhelm the long-term drivers underpinning commodity cycles.

In addition to the size and duration of a potential disruption, market participants also consider the availability of crude stocks and the ability of other producers to offset a potential supply loss. With global oil inventories declining to multi-year low and spare capacity largely in the hands of few Middle east producers, markets will remain on a tenterhooks as the crisis unfolds.

While geopolitical tensions heightened by the Middle East conflict pose the biggest threat to the oil market, the short-term market sentiment for oil appears to be fragile due to demand fears.

Growth indicators from industrial output data to PMI and sentiment readings in recent weeks are all suggesting that the euro zone’s economy is now either stagnating or even shrinking as weak external demand, consumer caution and high interest rates take their toll. This poor economic data is corroborated with the fresh data which showed a sharp decline in French road transport diesel demand in September.

The U.S. economy remains resilient when compared to the Eurozone, however，one of the indicators is still flashing a warning signal from the US Treasury yield curve.

The so called re-steepening of the Treasury yield curve into positive territory from an inverted position has historically proven to be the most reliable market indication of imminent recession risk.  As interest rate hikes start to take their toll, markets are widely expecting the Fed to keep rates on hold at its policy meeting this week.

On the physical market, a downturn of oil refining margin due to slowing demand is casting a shadow over the prospects for global crude oil demand.

As it stands, global gasoline cracks are showing signs of stabilizing buoyed by supply-demand rebalancing after the slump since August, but the restart of refineries post maintenance could still lead to an oversupply. Spot diesel cracks was down another 10% on the week to a fresh three-month low this Monday, and may face further downward pressure because fuel makers focus on maximizing diesel output and a potential increasing supply from Russia.

The prompt-month calendar spread for JPX Dubai crude oil futures fell to one month low, while the same spread for ICE Brent crude oil futures was seen traded at a low level not seen since mid-September, indicating a possible return of glut.

Given the prevailing geopolitical context and market dynamic, markets will be keeping a close eye on OPEC’s next meeting scheduled in late November when OPEC and its allies plans for production levels in the coming year. Some experts say Saudi Arabia could begin easing its production cut sooner than expected in order to maintain market share and revenues and avoid demand destruction through too high prices.

To reduce overreliance on upstream revenue, the world’s top crude oil exporter Saudi Arabia has been making efforts to integrate further into downstream business like oil refining and petrochemicals, upstream’s share of total sales fell from 66% in 2018 to 49% in 2021. The strategy has also enabled Saudi Arabia more flexibility in adjusting its crude output policy.