Fed Rate Cut Hopes Lift Oil: Will Supply Risks Take Over?

On Dec 8, with prices hovering near two-week highs, global oil markets started the week on a firm footing. Brent crude futures rose 9 cents (0.14%) to $63.84/barrel (by 0321 GMT). However, the US WTI (West Texas Intermediate) crude rose 8 cents, 0.13% to $60.16/barrel.

In the previous week, both benchmarks had closed at their highest levels since Nov 18, signalling a tentative sentiment recovery. This surge was led by the widespread expectation of a shift in the US monetary policy.

Currently, markets have placed an 84% probability of a quarter-point interest rate cut by the US Federal Reserve at its meeting on Dec 9 -10.

Typically, a rate cut can weaken the dollar and boost economic activity, surging the oil demand. However, geopolitical risks involving major producers such as Russia and Venezuela persist. Also, there are looming fears of a structural oversupply in the medium term.

So, will the Fed’s monetary stimulus be enough to offset the bearish fundamentals of a well-supplied oil market?

Are Geopolitical Supply Risks Real?

The physical oil market is grappling with tangible supply risks. In Europe, the slow progress of peace talks in Ukraine has kept the risk of disruption alive.

Reportedly, the G7 (Group of Seven) countries and the European Union are discussing an escalation in sanctions. Such escalations might replace the current price cap on Russian oil with a full maritime services ban, targeting the Russian export logistics. This might result in potentially curbing supplies from the world's second-largest producer far more effectively than the price cap did.

Simultaneously, tensions are rising in the Americas. The US has ramped up pressure on Venezuela, which is an OPEC member with massive heavy crude reserves, heightening concerns about potential disruptions.

Analysts at Rystad Energy have warned that, despite Venezuela's current output being modest at ~1.1 mn barrels per day (bpd), its crude is heavy and unique. Meaning any disruption would disproportionately impact buyers such as India and China, who rely on it for their complex refineries.

These geopolitical events have created a "risk premium" in oil prices (although more or less fragile).

ANZ analysts note that a potential resolution to the Ukraine conflict might conversely unleash a "swing in oil supply of more than 2 mn bpd" back onto the market.

This can be a binary outcome. It might either lead to a supply crunch from sanctions or a supply flood from peace. Thus, the geopolitical landscape is a double-edged sword for oil bulls.

The China Factor

Independent Chinese refiners, or "teapots," have stepped up their purchases of sanctioned Iranian oil. These refiners are drawing down onshore storage tanks. With this, they are effectively absorbing some of the "shadow" supply that might otherwise flood the global market. Newly issued import quotas have positioned them to utilise this potential.

Furthermore, Chinese refiners are preventing a glut in the spot market by clearing discounted Iranian barrels. However, this also signals that end-user demand in China remains price sensitive.

Refiners are opportunistic buyers of cheap, sanctioned crude rather than aggressive bidders for benchmark grades. Despite the existence of supply risks, the market is not currently facing a physical shortage. Thus, amidst global tensions, China is continuing to play its role as the market's safety valve.

A Delicate Balance

The current rally in oil is built on a delicate balance between:

• Monetary hope of a Fed rate cut, providing a demand-side floor
• Geopolitical fear involving Russia and Venezuela, which creates supply-side upside

However, the medium-term outlook remains bearish. In the current market dynamic, the asset prices might reflect all available information, including anticipated future policy shifts like the Fed's rate cut. Furthermore, the geopolitical risk premium of Russian and Venezuelan oil might lead to potential disruptions to the production function. This might result in immediate price adjustments even before the physical supply is curtailed.

Source

Economic Times
Rigzone
Reuters
Fastbull