Despite heightened geopolitical tensions, gains in crude oil remain capped
The previous week saw WTI crude oil approaching a 6-month high amidst escalating tensions in the Middle East. However, it relinquished most of its gains, closing 1.4% lower for the week at $85.66 per barrel. The reversal occurred as ongoing conflicts have not significantly disrupted oil supplies, and market attention has shifted towards concerns about inflation, leading to worries about slower rate cuts.
Oil’s performance and the key triggers
Crude oil rallied around 18% so far this year with OPEC+ supply cuts and elevated geopolitical risks in Russia and the Middle East.
Geopolitical triggers: Middle-East tensions have not directly affected supplies yet but supply chain risk is adding war premium to oil. However, Ukrainian drone attacks on Russian oil refineries risk disrupting trade in petroleum products like diesel. Ukraine has targeted refineries with a combined capacity of about 3.4 mbpd.
Demand supply triggers: Moving on to the OPEC+, the cartel’s supply cuts extending into the Q2 is likely to keep oil markets in deficit for yet another quarter. Consumption has also been running at a good pace in leading economies. US and China PMI expanded in March giving positive demand indications. Recent data on China’s first-quarter growth beat expectations.
Signals from Key barometers: Besides the current happenings, the key oil barometers including spreads, long-short positions, and options positions are also flashing positive price signals. WTI first and second month spreads are in widening in bullish backwardations indicating tight supplies in the near term. Secondly, although prices slipped late last week, the trading floors witnessed a cautious optimism with Money managers increasing their net long positions in U.S. crude futures.
Outlook for the Short Term
Iran’s unprecedented attack on Israel over the weekend was well- and thus market reaction was largely muted. The focus is now shifting to the nature and timing of the next Israeli move. The Middle East accounts for about a third of global crude supply. The possibility of a direct response from Israel means that this uncertainty and tension will linger for quite some time. This, along with restrained supplies from OPEC+ and US summer travel demand would keep sentiments positive.
However, one thing is to be noted the gains in oil prices have come despite a steady strengthening of the US dollar, which has climbed to the highest level since mid-November. Typically, that can be a headwind for commodities. Meanwhile with higher prices comes inflationary concerns and thereby the higher for longer narrative and eventually the slowdown fears.
All these will eventually keep crude oil markets volatile for the weeks ahead. Any escalation in conflicts this time would mean WTI oil crossing the key resistance level of 87.50 (CMP: $86 per bbl) and may test $92/94.50 levels as well. However, as long as war remains constrained prices may trade in the broader range of $83.50-87.50 levels.