“Why Oil Prices Increased Despite Ignoring a Crisis”
Oil prices have experienced an upward trend, driven by factors beyond the recent turmoil in the Red Sea. Last week, futures on Brent crude surged by over 6% to settle at $83.55 per barrel, reaching their highest level since early November. This increase can be attributed to a combination of factors, including winter storms that disrupted U.S. oil production and robust demand for fuel in the country’s economy, which remains resilient despite the challenges.
The recent upsurge in oil prices has been somewhat unexpected, given the growing likelihood of the Israel-Hamas conflict escalating into a wider conflict. However, a series of events in recent weeks have contributed to the market’s unexpected movements.
On Monday, Brent crude prices retreated by 1.4% despite another attack by Yemen’s Houthi rebels on an oil-carrying vessel over the weekend. This highlights the complexity of the factors influencing the oil market.
The recent gains in oil prices can be traced back to earlier this month, when winter storms and extremely cold temperatures affected a significant portion of the country, resulting in a slowdown of approximately 1 million barrels of crude output per day in the United States, accounting for around 7.5% of the country’s typical daily production.
Furthermore, last week’s data revealed that the economy grew at a 3.3% annual rate in the fourth quarter, adjusted for inflation, which was better than the 2% forecast by economists and raised expectations for fuel demand.
The oil market has been experiencing unexpected movements due to a combination of factors, including the impact of winter storms on U.S. crude output and the stronger-than-expected growth of the economy, leading to increased demand for fuel.
It is currently uncertain how much further prices will escalate in the near future. The recent surge in oil prices has triggered significant buying activity from a large contingent of trend-following traders, according to Daniel Ghali, a commodity strategist at TD Securities. However, for prices to continue to rise, more traders will need to be convinced to participate in the rally, placing the onus on other market players to maintain the momentum.
Despite the recent price increases, many traders have been burned by short-lived price surges in the past two years, noted Scott Shelton, energy analyst at United ICAP. Geopolitical events such as Moscow’s invasion of Ukraine, Western sanctions on Russian exports, and OPEC production cuts have failed to generate a sustained price jump. As a result, this trade has proven to be highly volatile and risky.
Furthermore, the latest global risk, the threat of an expanding Israel-Hamas war, has failed to lead to a lasting increase in prices, highlighting the fleeting nature of these threats. The lack of a consistent and sustained drivers of price growth suggests that the market may be approaching a plateau, with prices potentially stabilizing in the near term.
Prior to last week, the prices of futures contracts for Brent crude oil had remained relatively stable in the $70 range for six consecutive weeks, significantly lower than their pre-October 7th level. This was despite the ongoing conflicts in the region, including the diversion of oil tankers and attacks on shipping vessels in the Red Sea, as well as flare-ups in Iran, the West Bank, and off the coast of Oman. Analysts at J.P. Morgan have determined that there has been no significant geopolitical risk premium built into current petroleum prices.
The lack of major supply disruptions has contributed to a lack of market panic, despite recent attacks. In fact, option-implied volatility, a measure of the cost of insuring against oil price spikes, initially surged to over 50% after Hamas attacked Israel but has since decreased to around 36%, which is a relatively tranquil level and close to what it was before the attack. The Houthis’ attacks on shipping vessels appear to be more focused on disrupting traffic rather than taking out specific targets, according to Vikas Dwivedi, global energy strategist at Macquarie.
In a recent report, Deutsche Bank analyst Michael Hsueh expressed skepticism that the Yemeni rebels will extend their campaign to the strategic Strait of Hormuz, which handles approximately 20% of the world’s oil traffic. According to Hsueh, such a move would be too detrimental to Iran, a key ally of the Houthi rebels, which relies on the Strait for its oil exports.
While the disruption of Red Sea shipping may have a minor impact on oil supplies, J.P. Morgan Commodities Research has assessed that the consequences are manageable. The bank estimates that the detour for affected ships adds eight to nine days to their voyages and incurs a negligible $2 per barrel increase in prices.
The temporary nature of these delays is expected to have a limited impact on oil prices, as evidenced by the recent surge in front-month Brent futures of over $6.50 per barrel since January 10th. However, the price increase for later delivery periods has been significantly less, suggesting a transitory nature to the disruptions.
“The global oil market is facing a surplus of crude oil, driven by an oversupply from non-OPEC countries such as the United States, Brazil, and Guyana. According to the International Energy Agency, these countries are expected to exceed global petroleum demand growth in 2024, contributing to a build-up in oil inventories. Expansion of offshore projects could further exacerbate the glut in 2025. As the pandemic’s aftereffects subside and the adoption of electric vehicles gains momentum, oil demand is expected to slow, leading to a significant increase in global oil inventories. In light of these developments, Citigroup’s analysts have advised clients to sell oil rallies in early 2024 before the market is hit by the surplus in 2025.”
In the event of unexpected disruptions to global energy supplies, such as natural disasters or surges in demand, idle production capacity could prove to be a valuable safety net. As of now, the Organization of the Petroleum Exporting Countries (OPEC) has an excess of nearly five million barrels of daily production capacity, as reported by the US Department of Energy, which is significantly higher than its pre-pandemic average. This extra capacity could be leveraged to bridge any gaps in supply and meet global energy demands.
