As if Joe Biden had welcomed the Iranian president-elect, Ebrahim Raisi, in the White House two days before his swearing in and as an inauguration present lifted all the sanctions the US had imposed on his country and promised him unfettered access to the international oil markets. That was the feeling after the sharp drop in oil prices yesterday afternoon.
The reason, however, is more prosaic. It is the combination of the continuous threat the Delta variant poses to the economy and the related dismal reading of the performance of manufacturers. The Chinese factory activity fell to 50.4 versus an expectation of 50.8, according to the official figures. The Caixin/Markit survey that includes smaller manufacturers has also shown considerable weakness as the index dived to 50.3, the lowest reading since last April. Although the manufacturing sector in the eurozone was active last month any hopes of a rally from the morning’s tepid action were dashed when it became apparent that this segment of the economy in the US slowed last month. The ISM index of the country’s factory performance fell to 59.5 in July, down from 60.6 the previous month.
Slowing manufacturing provided the perfect excuse for yet another Monday rush towards the exit. The two main crude oil futures contracts lost about $2.50/bbl and products fell roughly the same extent. Not even the flare up in geopolitical tension could provide an immediate support. Instead of the imaginary US-Iranian embrace the two nations were at each other’s throats again. The US and its allies accused the Persian Gulf nation of attacking an Israeli oil tanker off the coast of Oman, which killed two crew members. The Iranian rebuttal was swift and harsh and warned of a prompt response to any threat against its security.
Dips should be short-lived
It is dubious that weakening manufacturing activities will cause a long-lasting scar on the face of the global economy. And if that is the case money managers might swing into action again soon. After deserting the oil market two weeks ago financial investors once again poured money into the two major crude oil contracts last week. The latest report from the CFTC and ICE shows that net speculative length (NSL), futures and options combined, rose by a total of 53 million bbls during the week ending July 27. This increase was primarily driven by Brent where NSL was up by 50 million bbls compared to 3 million bbls in WTI. Brent now has more than 49% of the cake made of crude oil, very close to the year’s high reached at the end of January. The increase in NSL was predominantly the result of a rise in gross long positions – 35 million bbls in Brent and 10 million bbls in WTI suggesting the return of appetite for risk – at least for temporarily. About $46 billion of speculative money was tied up in the two crude oil benchmarks for the latest reporting period, a weekly jump $7 billion but this amount is still $8 billion lower than this year’s peak.
The dilemma funds and money managers are currently facing is whether to add to their NSLs, sit on their positions or given the uncertainties surrounding the global economy and the fragile oil balance be conservative and gradually get rid of them and find other asset classes to put their money into. Judging by yesterday’s carnage it is the latter that affects their thinking. Yesterday’s exit from the market has not been slow or gradual but the herd stampeded towards the exit. Nonetheless, yesterday’s price fall by no means indicates a prolonged change in sentiment.
After yesterday’s sharp price drop market players will quickly get away from the noise and try to figure out what the macro-economic picture and the global oil balance tell them – is there still some decent upside potential or under the current circumstances the top has been found at the beginning of July?
Their major concern is obviously the coronavirus and its Delta variant that is spreading speedily in several parts of the world endangering economic recovery. As the battle against the disease continues it will not be lost on the money managers that infections are chiefly rising amongst the younger generation in the developed part of the world. It means that hospitalization and therefore death rates will unlikely come anywhere near to the awful numbers that were registered a little over a year ago. Locking down regional economies, especially where vaccination is not prevalent yet, will be, albeit probably inevitable, short-term measures.
Because of the uneven vaccine rollouts, rich countries fare much better than emerging economies. When Brent settled at its multi-year high on July 5 the S&P 500 index, for example, was lower than it is right now. During the last month or so the US stock markets has edged optimistically higher whilst oil has lost value implying that it is the developing part of the world that causes headaches amongst investors. And true enough, the MSCI Asia-Pacific index (excluding Japan) is also considerably weaker than it was a month ago. Encouraging economic data from emerging countries, which are currently AWOL, will provide a much-needed confidence boost for oil bulls. The interesting aspect of global demand concerns is that other raw materials perform much better than oil. Front-month Brent has shed 5.5% of its value since the beginning of July, yet, the Refinitiv/CoreCommodity CRB Index has remained resilient and stable implying that demand for other commodities remains healthy. It could be another indication that any dip, just like the ones two weeks ago and yesterday, is likely to be brief.
Fears of inflation also weighs on investors’ sentiment. Although supply chain bottlenecks and assorted stimuli have driven commodity prices higher and caused shortages in certain areas the bond market seems calm. The 10-year US Treasury yield is way off the highs of 1.73% seen in March and settled at 1.17% yesterday.
There are two more pieces of the jigsaw puzzle that needs to be looked at before one draws a conclusion on oil prices for the rest of the year. The first one is the supply-demand oil balance. Even as the OPEC+ group has started the next round of tapering of output constraints global oil inventories are set to deplete based on readily available data. The second one is the dollar. Its recent strength has most likely negatively impacted oil demand from the developing part of the world but the hit on consumption there was more than offset by robust demand growth elsewhere – as confirmed by the latest estimates. The prolonged spread of the coronavirus is disappointing. Consequently, the world is coming out of the health crisis more slowly than anticipated at the beginning of the year. These setbacks, however, will only raise low and temporary barriers on the way to full global recovery.