A Looming Crude Oil Showdown

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by Tyler Durden
Monday, Sep 20, 2021 - 10:40 PM

By Ryan Fitzmaurice, senior commodity strategist at Rabobank


  • As expected, China’s recent attempt to pressure oil prices lower has so far been unsuccessful

  • All eyes will be on the next OPEC+ meeting to see if Saudi Arabia will surprise the oil market by slowing or pausing planned production increases in response to China’s SPR release

  • US CPI inflation data for August registered a +5.3% year-on-year gain in consumer prices

  • The broad-based commodity indices are signalling even more upside inflationary pressures ahead, as those indices reached new multi-year highs just this week

Oil prices were strong last week, setting new multi-week highs much to the dismay of large oil consuming nations that are fighting soaring commodity price inflation. This is particularly true for China given that crude oil imports there have soared back above the 10mb/d mark in recent data.

Moreover, China’s recent attempt to pressure oil prices lower by announcing its intention to release oil from its strategic petroleum reserve (SPR) has so far been unsuccessful, a dynamic we discussed in detail in last week’s note. Further reinforcing our thesis, oil prices fell suddenly again on Tuesday morning as more details of the Chinese SPR release were announced, however, the bearish market reaction was very short-lived and oil prices went on to quickly recover and settle higher on the day, just as they did last week when news of the Chinese SPR plans first hit the wires. Notably, ever since the pandemic hit, OPEC+ holds a virtual conference call every month to adjust supply to current market conditions with the stated goal of reducing global stockpiles and the unstated goal of increasing oil prices and revenue.

As such, all eyes will be on the next OPEC+ meeting, scheduled for October 4th, to see if Saudi Arabia will surprise the oil market by slowing or pausing planned production increases in response to China’s SPR release. This is a real possibility, as we see it, and especially in light of the Saudi Energy Minister’s recent comments indicating he still has “tricks up his sleeve” and suggesting he would inflict financial pain on those that seek to impede the OPEC+ mission.

Importantly, if there were to be a surprise on the supply side, it would likely have a much bigger impact on oil than the Chinese SPR release has, given that OPEC+ controls nearly all of the available spare capacity. In addition to that, OPEC+ has the powerful herd of systematic algos on its side doing the heavy-lifting and bidding oil prices higher.

Commodity inflation

As we noted in the onset, soaring commodity price inflation has put large consuming nations on the defensive this year. Further to that end, US CPI data for August was released on Tuesday and registered a +0.3% month-on-month gain which equated to a +5.3% year-on-year gain in consumer prices. Moreover, this was the fourth consecutive month that consumer inflation has come in at or above 5% y/y with no signs of letting up. In fact, the broad-based commodity indices are signalling even more upside inflationary pressures ahead, as those indices reached new multi-year highs just this week, thanks in large part to the gains in oil and gasoline prices.

The CPI data release also prompted comments from President Biden yesterday in which he suggested that gasoline prices were somehow being artificially propped up despite evidence that they should be lower, as he put it. The President did not provide any detail as to what evidence there is to suggest gasoline prices should be lower which left many traders and analysts scratching their heads. On the contrary, we see considerably more upside risks than downside risks to oil and gasoline prices into year-end and even beyond. As it stands, both fundamental and quantitative market signals are overwhelming bullish and the speculative positioning has plenty of room to grow from current levels as we discussed last week. Perhaps more important though, is the revival in commodity index investing that was such a key driver for commodity markets in the first half of the year. On that note, the massive capital inflows into commodity index products witnessed in the first half of the year have gone dormant in recent months, a dynamic we detailed here. However, in our view, it won’t be long before institutional investors and large asset managers are forced to increase commodity index allocations as surging inflation expectations and fear of missing out forces capital off the side-lines. As such, we fully expect to see a notable pick-up in commodity allocations in the coming weeks and months given the well-known inflation hedging benefits commodity indices have historically provided. Furthermore, commodity markets are the best performing asset-class year-to-date with gains of more than 25%, so those asset allocators that have remained underweight commodities have missed out on the strong risk-adjusted gains and are very likely underperforming their peers and benchmarks.

Looking Forward

Looking forward, we see real potential for a bullish OPEC+ surprise at the upcoming October meeting in response to China’s recent SPR release. As we noted, OPEC+ currently has the herd of systematic algorithms on its side helping to bid up prices. Further to that end, aggregate open interest for petroleum futures increased this week as prices rose, signalling new speculative “long” positions are likely being established.

Furthermore, we see the potential for a large increase in commodity index allocations as a result of surging inflation worries coupled with fears of missing out (FOMO) on the strong absolute and relative performance of commodity markets this year.