A tight physical supply
in crude markets could drive oil prices up even further.
Demand has proven more resilient to the effects of Omicron than many analysts had initially thought.
With the physical and futures markets recovering and the geopolitical premium rising, market watchers are looking towards the $100 mark for oil prices.
Physical raw cargo prices have risen this year, signaling resilient global oil demand, even in the face of record COVID cases in the Omicron wave. Crude grades from the United States, Africa, North Sea, Middle East and Russia have seen significant price increases in recent weeks, suggesting that physical demand for oil is tight in the world.
The tightening in physical crude prices is reflected in the oil futures market where the backwardation – the market condition signaling tight supply – has increased for the two main benchmarks, Brent and WTI.
Tight physical oil supply points to further gains in the futures market, where Brent prices hit a new seven-year high at over $87.80 a barrel early Tuesday – the highest Brent price since October 2014.
Part of the rally in recent days was the result of heightened geopolitical tensions in the Middle East and the standoff between Russia and the West over Ukraine. But the other major factor has been tight supply in the market, with physical freight prices rising, outages in major producing countries and demand resisting the Omicron surge.
Traders and refiners seem to believe the feared threat to demand for the new variant was overblown and are now back in the market buying much more shipments than they did in late November and early December when the impact of ‘Omicron was still very important. great imminent threat.
Strong physical demand for oil
Since the beginning of the year, prices for crude oil shipments that will end up in the world’s largest importing region, Asia, in two or three months’ time have rebounded strongly, as refiners have returned to the market after a some hesitation at the end of 2021 amidst the unknown effects of Omicron on demand.
Consumption is resilient, belying fears of a further decline and holding up better than many analysts and forecasters, including the International Energy Agency, predicted.
Global oil demand has proven more resilient to the effects of the spread of the Omicron variant than the IEA predicted, chief executive Fatih Birol said last week.
“Demand momentum is stronger than many market watchers thought, primarily due to more moderate expectations from Omicron,” Birol said, as quoted by Bloomberg.
Due to this resilient demand, refiners are buying up cargo, which is driving up physical crude prices from all parts of the world.
“These are crazy numbers. There is clearly a physical tightness,” an oil trader in the North Sea region told Reuters over the weekend.
Bounties for North Sea Forties and Ekofisk grades are at their highest in two years. Prices for West African crude grades have also surged amid weak Libyan supply in recent weeks.
North Dakota Bakken crude is also trading at its highest level against benchmarks in nearly two years, according to Bloomberg estimates.
Price spreads for Russian and Middle Eastern grades also widened to multi-month multi-month benchmark levels.
“Buyers are grabbing everything, regardless of quality,” a U.S. oil trader told Reuters.
“The physical crude market is well above futures or futures. It involves real quick sealing,” PVM Oil Associates analyst Tamas Varga told Bloomberg last week.
Physical tightness is reflected in the oil futures market
This week, PVM Oil Associates said in a note Monday that “Positive developments were front and center and there is genuine belief that physical demand will continue to outstrip supply and in turn this perceived bullish backdrop will further encourage investors to stay loyal to our market.”
The stretched physical market suggests the futures market still has room to rally, traders and analysts said.
“Quick spreads on WTI and Brent remain elevated at 63 and 74 cents a barrel, signaling growing tension,” Ole Hansen, head of commodities strategy at Saxo Bank, said on Monday.
“Speculators, a bit behind the recent rally, boosted bullish WTI oil bets and Brent bets to the 14-month high last week,” Hansen added, noting that the combined net long – the difference between bullish and bearish bets – on Brent and WTI jumped the most last week since November 2020 to reach 538,000 lots or 538 million barrels. That’s still well below the most recent peak at 737,000 lots from last June, he said.
With the physical and futures markets rallying and the geopolitical premium increasing, market watchers are once again asking the question: how far can this rally go?
According to the world’s largest independent oil trader, Vitol, oil prices – at their highest level in seven years early on Tuesday – are justified and still need to go higher.
Triple-digit oil “is in the works” for the second quarter, Francisco Blanch, head of global commodities at Bank of America, told Bloomberg last week.
Demand is picking up significantly, while OPEC+ supply will begin to stabilize over the next two months, Blanch said, noting that Russian supply will stabilize and only Saudi Arabia and the Emirates United Arab Emirates (UAE) will be able to produce additional barrels to add. at the market.
Of course, the downside risks have not disappeared. The biggest unknown and biggest potential headwind to near-term global demand is China, and whether it would continue with its zero-COVID policy, BofA’s Blanch said. Extensive lockdowns at the world’s largest oil importer could reduce consumption and potentially Chinese oil imports.
Spring refinery maintenance could also slow the physical oil market, analysts said.
Still, oil’s rally may not be over yet, especially if demand continues to reflect only a “mild Omicron effect.”
By: Tsvetana Paraskova
Paraskova reports for Oilprice.com.