Oil Q4 outlook 2023

Oil market dynamics and global economic implications

By Raed Alkhedr | @raedalkhedr | 2 November 2023

Will WTI reach $100 per barrel_
  • China capitalizes on discounted Russian oil, contributing to its second-highest crude oil imports in August.

  • US oil inventories have sharply declined since the beginning of 2023, reaching their lowest levels since December 2022 at around 420 million barrels.

  • Global oil prices have risen by approximately 30% since mid-June, reaching $90 per barrel, driven by supply cuts from an agreement between Saudi Arabia and Russia.

Will WTI reach $100 per barrel?

Global oil prices have soared approximately 30% since mid-June, following an agreement between Saudi Arabia and Russia to cut supplies to support global prices at a time of continued demand concerns.

Earlier this month, both nations decided to extend their supply cuts by 1.3 million barrels per day until the end of the year, which has contributed to the ongoing increase in oil prices, pushing them up to $90 per barrel.

The Saudi Energy Minister has stressed that OPEC+ is primarily focused on maintaining the stability of oil markets, although they don't have specific target price levels in mind. Furthermore, he pointed out that the organization conducts regular monthly assessments of its production plans.

Impact of the conflict between OPEC and the IEA on energy stocks

The International Energy Agency (IEA) continues to warn against the policy of cutting supply being pursued by some OPEC+ members.

It has emphasized that global demand levels do not necessitate such cuts, with global economic pressures and recession fears, especially in China, still persisting. Reacting to this, OPEC+ has asserted that its actions do not target a specific oil price but are taken on an assessment of the current fundamentals being seen in the global oil markets.

This divergence of views between the IEA and OPEC+ has put pressure on energy stocks, leading to an expectation of increased short selling of oil company stocks, especially as oil prices approach the $100 per barrel mark.

Expectations for global demand recovery

Given China's significant oil consumption, the strength of the Chinese economy indeed holds substantial influence over global oil prices. Although a robust recovery hasn't materialised following the relaxation of the zero-covid policy, recent economic indicators are beginning to show signs of improvement.

Retail sales have posted four consecutive months of growth, while industrial production remains off the lows seen last year. The Chinese government has also implemented targeted support measures to stimulate economic activity, including the reduction of stock fees - marking the first such reduction since 2008. This move is intended to encourage investment and, by extension, economic growth.

As a result, J.P. Morgan has raised its projections for Chinese economic growth in 2023 from 4.8% to 5%. If subsequent economic data releases indicate a resurgence in the Chinese economy, it’s highly likely that expectations for oil prices will be upwardly revised.

China turns to Russian oil

In recent months, China has been particularly focused on acquiring low-priced Russian oil, capitalising on the reduced prices resulting from Russia's need to sell its oil at a discount following of international sanctions.

Data indicates that China's total crude oil imports in August reached their second-highest levels ever recorded. Nevertheless, if we exclude the reasonably priced Russian supply from the equation, there was only a modest increase of approximately 2% in comparison to December 2022 levels. This implies that Chinese authorities may be taking advantage of the cost-effective Russian oil prices as a strategy to enhance their strategic oil reserves.

US oil inventories decline

Oil inventories

Since the beginning of 2023, US oil inventories have seen sharp declines, and are expected to continue shrinking. Record demand, supply cuts by producers, weak futures contracts, and increased storage costs, continue to suggest inventories will decline further going forward.

US oil inventories have reached their lowest levels since December 2022, at approximately 420 million barrels, giving another clear headway for oil prices to keep on rising.

Hedge funds dump energy stocks at fastest pace in six months

In its latest report, Goldman Sachs indicated that for the first time in three weeks, hedge funds let go of energy stocks in September, despite a significant increase in oil prices resulting from supply cuts. According to the bank's main financial brokerage unit, this move was primarily driven by short selling, as hedge funds anticipated a significant decline in energy prices in the upcoming period.

Goldman Sachs pointed out that hedge fund holdings in energy stocks is approaching its lowest levels since May 2020. Hedge funds have been intensifying their short-selling positions on American energy stocks, encompassing oil, gas, consumer fuel, and energy equipment and services.

Market concerns that the global economy is slowing remain high, with fears that activity may stall in China, the world's second-largest economy, a significant factor driving these fears. Accordingly, the view of the hedge fund community is that, despite the decision by some OPEC+ members to cut oil production, if a global economic slowdown materialises, so the lower demand for oil that this will translate into can be expected to put downwards pressure on international oil prices.

Oil prices outlook

Recently, expectations of rising oil prices to reach $100 per barrel have emerged. The OPEC+ policy and the confirmation of Saudi Arabia and Russia that the production reduction policy will contribute to achieving balance in the global markets may continue to support global prices.

This comes at a time when US oil inventories continue to decline, leading to an increase in supply shortages. However, the rate of increase in global oil prices will remain dependent on the extent of improvement in global demand rates. If demand continues to recover from China's side and the second-largest economy in the world remains stable, it may somewhat exert pressure on global prices.

However, it should be taken into consideration that China's inclination towards Russian crude oil and the concerns that include the pressures that the Chinese economy may face and that it has not reached the levels of recovery that support increased demand for oil. Therefore, if the current conditions persist, oil may not find a way to reach $100 per barrel before the end of the year.

Could rising oil prices prompt US Fed to reconsider its monetary policy?

In the latest meeting, the Federal Reserve kept interest rates unchanged and affirmed that the bank is pursuing a ‘soft landing’ policy, meaning it may maintain interest rates at elevated levels for a longer period but will not rush the pace of monetary tightening again.

However, it should be taken into consideration that a resurgence in oil prices raises concerns about inflation and thus the return of central banks to accelerate the pace of interest rate hikes. Rising oil prices impact everything, from gasoline prices to transportation and production costs for consumer goods. Undesirable pressure on inflation comes amidst generally low prices throughout 2023.

So far, the US Federal Reserve, along with most central banks, maintains that the current conditions do not warrant continuing a strong interest rate hike pace. However, if oil prices continue to rise and surpass $100 per barrel, the Federal Reserve may abandon its ‘soft landing’ policy and revert to raising interest rates. Ultimately, this could lead to renewed concerns about a global economic downturn.

The divergence between real and core CPI

Due to the rise in oil prices, there has been a clear discrepancy between real inflation rates and core inflation, which excludes changes in food and oil prices.

This issue has become more pronounced in Europe. Recent data has shown a slowdown in the growth of real inflation, but when we look at core inflation, we find that it has accelerated somewhat due to the increase in oil prices.

Therefore, the continued increase in oil prices may put pressure on central banks in the coming period. It may be argued that the current spikes in core inflation are temporary. However, as mentioned earlier, the sustained increase in oil prices could have a lasting impact on most sectors, similar to what happened when oil prices rose in 2021 and 2022, prompting central banks to accelerate the pace of monetary tightening.