Oil markets break out of trading range

Oil prices have crashed out of the trading range they had set for 2023 with Brent and WTI futures falling to their lowest levels since the end of 2021. Brent fell to as low as USD 71.67/b this week while WTI has now fallen below USD 70/b, trading closer to USD 65/b. The immediate catalyst for the collapse in prices is the fallout from financial market instability related to the collapse of Silicon Valley Bank in the US and anxiety over the stability of Credit Suisse in Europe.

For most of the year oil prices have been oscillating between support from the China reopening trade and pressure from hawkish central banks and tighter monetary policy. This latest burst of financial anxiety adds another negative for prices in the near term. From a fundamental perspective, the volatility introduced by stress in financial markets doesn’t change anything for oil. Balances had long been set up for a meagre Q1 with a surplus of 800k b/d thanks to a soft pace of demand growth and steady if not spectacular supply. Commercial stockpiles in the US have risen to 480m bbl, their highest level since mid-2021, thanks to soft demand amid stable production levels. Product stocks have also been on the rise—both in the US as well as in major trading hubs in North-West Europe and Singapore.

But volatility in financial markets generally will be a drag on oil and downside risk will increase in the near term. The current sell-off appears sentiment driven given there has been no shift in fundamentals. Both front-month Brent and WTI futures have moved to over-sold positions as investors dump any risk assets while a recent build in net length in the speculative Brent market means there are ample positions to be run down. Put skews in options markets are also tilting negative but they not at extreme levels which would suggest that the scale of further downside may be limited.

Balances to switch to deficit in H2

Provided that the stress in financial markets is contained, the remainder of the year still looks constructive for oil. The latest projections from the IEA would suggest that Q2 2023 is likewise set up for another surplus although at a narrower level than Q1. Demand growth is set to improve to 2.6m b/d y/y in Q2 from 0.7m b/d in Q1 and from thereafter demand growth will remain above 2m b/d, considerably ahead of pre-pandemic levels. The anticipated rebound in China’s oil consumption—with jet fuel demand alone set to rise by 69% y/y—will help to keep oil demand resilient this year even amid the anxiety over a recession in major economies.

Steady supply

Set against this will be a stable-at-best supply picture. Supply from Russia, impacted by sanctions from the US, EU and others, has been notably resilient since Russia’s invasion of Ukraine as exporters have been able to find new destinations in markets like India. Russia is set to cut production by 500k b/d in March and output is still widely expected to decline as the loss of key export markets like the EU limits Russia’s options.

Meanwhile, the rest of OPEC+ has chosen to hold production levels flat amid an uncertain macro outlook. The next official ministerial meeting is set for June which seems an eternity away amid the volatility currently at play in markets. Should the oil price continue to sell off in a disorderly manner we would expect to see more verbal intervention from OPEC+ ministers or even an emergency meeting to announce changes to production targets to anticipate a drop in demand prompted by recessions in major economies. Lower output targets though will likely create friction within the OPEC+ framework and the threat of individual members staking out on their own. If the storm in financial markets is contained to specific institutions, we would expect OPEC+ to remain on the sideline and maintain output levels unchanged for the remainder of 2023.

Prices still set to rise

Our baseline on price assumptions for 2023 was that prices would rise over the course of the year as oil market balances show two very distinct halves in 2023 and we still believe that trajectory is supported by fundamentals, if now on a shallower path. We now project Brent at an average of USD 84/b in H1 before rising to USD 90/b in Q3 and USD 95/b in Q4 for an annual average of USD 88/b. For WTI the trajectory is similar, moving from an average of around USD 79/b in H1 to USD 85/b in Q3 and USD 90/b in Q4, bringing the average to USD 83/b for the year.