The three key takeaways after yesterday’s performance are as follows: inflation and rising interest rates are not a worry in the oil market for the time being, the partial re-introduction of Covid-curbs in China is not expected to negatively influence oil demand and finally, tightness in the product market is not just a very real danger but a tangible development.

The ECB has turned hawkish and finally joined “the interest rate club”. A rate hike of 0.25% in July was always anticipated but the central bank sent out a strong signal yesterday that it could be followed by a 0.5% increase in September. It is the clearest sign yet that rising inflation, which shot up to 8.1% can only be dealt with by cooling down the overheated economy and make borrowing expensive. Today’s US CPI data will provide a fresh hint whether inflationary pressure on the other side of the Atlantic is close to its peak but judging by falling stock markets the top is not in sight just yet or if it is the retreat will not be a steep decline.

China was also in focus. Two of its biggest cities, Shanghai and Beijing raised the alarm once again because of Omicron flare ups. The former imposed fresh restrictions while the capital city closed entertainment venues. These developments, however, were outweighed by rising Chinese exports data, a direct consequence of which was a 2.5% month-on-month increase in crude oil imports that reached 10.79 mbpd in May.

Crude oil prices retreated yesterday but they probably would have fallen harder had products not provided decent support, an indication that summer demand is to exceed supply. The CME RBOB contract gained 543 points on the day after coming within a whisker of its record high. Heating Oil jumped 894 points and the expiring June ICE Gasoil contract rallied to its highest level since March 10.

Continuous upside potential

According to a seasoned oil market veteran the four main factors that play undisputedly relevant roles in the formation of oil prices are macroeconomics, the supply-demand balance, both current and future, oil market technicals and positioning. When all of these point to the same directions the stars are aligned for a decisive move. It is, therefore, as important as ever to have a thorough look at what the above-mentioned four elements currently suggest.

Macroeconomics: Wars always have a negative impact on economic growth and Russia’s invasion of Ukraine is no exception. When it follows an already uncertain growth environment its impact is amplified. Inflationary pressure had been growing prior to the beginning of the conflict as the post-Covid recovery and the related global supply chain bottlenecks, aggravated by recent Chinese lockdown measures, had been pushing both consumer and producer prices considerably higher. The attack on Ukraine has only exacerbated the situation given that Russia is a vital global energy supplier and both countries are significant exporters of agricultural products.

The pressure the global economy is under is felt everywhere. In its latest Global Economic Prospects report, the World Bank has revised down this year’s global economic growth projection by 1.2% to 2.9%. The growth in US and eurozone manufacturing sector slowed in May and although Chinese factory PMI rose it is still below 50 indicating contraction. US inflation was 8.3% in April and the May data, due out today, is expected to show inflation at elevated levels. The Fed is almost certain to hike rates in June and July. Eurozone inflation jumped to a record 8.1% in May and the ECB is intending to follow the Fed and others by increasing rates by 0.25% in July and possibly even more in September. Rising interest rates make borrowing more expensive, hindering aggregate demand growth and put pressure on equities. The MSCI Global Equity Index is down around 15% this year. The health of the global economy is precarious.

Oil balance: The economic malaise is unmistakably reflected in global oil demand figures. Between January and May global oil demand for 2H 2022 was revised down by 580,000 bpd due to inflationary pressure and the partial lockdown of the Chinese economy. At the same time international sanctions on Russia have taken their toll on the supply side of the oil equation and non-OPEC supply was revised down by 1.58 mbpd leaving the call on OPEC at 29.68 mbpd in May, 1 mbpd higher than in January. Clearly, the global oil balance has gotten tighter and with the hopefully protracted lifting of Chinese Covid curbs oil demand will get an extra adrenalin shot. This should ensure that OECD commercial stocks will remain resilient and might even decline further in 3Q and possibly 4Q. Admittedly, the EIA made a massive upward revision in Russian output in its latest monthly report but it will be interesting to see whether OPEC and the IEA will do the same next week and whether they will amend their global oil consumption estimates.

Charts: Technicians are convinced that any change in fundamentals are immediately reflected in technicals. If true, then the current technical backdrop neatly sums up the driving force behind oil prices. Brent is still in its current trading range but is about to break out on the upside. The top end of this range is the high on March 24 at 123.74. WTI broke above it. It is 116.64 and whilst holds over it, the US benchmark is considered constructive. RBOB, despite its recent retreat is positive and will remain so unless 389.04, the peak on March 7 is settled below. Heating Oil is also more on the positive side and the next bullish impetus will come on a conclusive settlement above 467.09, the continuation high on March 9. Gasoil looks healthy as long as it is above 1,300.00, the peak on May 2.

NSL: money managers and financial investor are turning cautiously optimistic on the two main crude oil futures contracts. Combined net speculative length in WTI and Brent has grown by 88 million bbls since the middle of April. At 496 million bbls, however, it is still significantly below the January peak of 565 million bbls. On one hand, it implies that there is room on the upside but on the other it shows that speculative money is reluctant to make a whole-hearted commitment to the upside (despite the attractive backwardation) because of economic considerations and high margins.

Apart from the macroeconomic anxiety the oil balance, technicals and positioning points to a resilient market with a pronounced upside bias. The recent price rise indicates that the market is influenced by supply considerations, and not by demand concerns. Potentially higher consumption due to the arrival of the driving season and possible Chinese economic revival will set worries about inflation aside and oil could easily edge further north in the next few months – of course with the usual sporadic corrections.