There is no getting away from Chinese demand destruction fears. The world’s second-biggest economy is under pressure from pandemic-related disruptions, and this is putting a downer on the near-term demand picture. Covid-19 curbs in Beijing were tightened yesterday as a new round of mass testing got underway. Authorities are doing everything they can to avoid a similar fate to that of Shanghai which has been under some form of lockdown for more than a month. The impact of these harsh restrictions is clear to see. Chinese factory activity contracted at the fastest rate in two years. Meanwhile, credit rating agency Fitch has cut its 2022 GDP forecast for China to 4.3% from 4.8%, and well below the government’s target of 5.5%.

Away from China’s Covid woes, market players are bracing for the prospect of a hike in US interest rates. The Federal Reserve is widely expected to announce a 50 bp increase in rates later today as it takes the fight to rampant inflationary pressures. Traders are also awaiting the latest round of EU sanctions on Russia which are likely to include a ban on oil imports. Returning to the US, focus will also be on dwindling oil inventories. Overnight, the API reported a decline in crude and fuel stocks. With so many catalysts at play, the stage is set for an intense bout of price volatility.

Higher, Lower or Stick?

Brent and WTI are enjoying their best run since early 2018 after racking up a fifth straight month of gains in April. That being said, the rally cooled towards the end of last month, so much so that both crude markers lost value over the second half of April. Weaker demand fundamentals in China and a resurgent dollar dampened upward pricing pressure for crude oil. More recently, oil bulls were spooked by signs of a revival in Libya’s oil fortunes. The country’s NOC has temporarily lifted a force majeure it imposed on the Zueitina oil export terminal. Furthermore, production has partially resumed at Libya’s largest oil field following last month’s unexpected shutdown.

In the wake of this recent period of price weakness, the number of traders’ net-long bets in ICE Brent fell in the seven days to April 26. This was the fourth weekly drop in five. Moreover, in the latest monthly Reuters price poll, analysts trimmed their Brent and WTI price forecasts for this year for the first time in four months. This suggests those banking on rising oil prices are getting nervous. Better said, doubts are creeping in that that prices will go up much further.

Is bearish momentum beginning to set back in? Unlikely. The fact of the matter is that the upside potential for prices remains considerable chiefly because supply concerns stemming from Russia are set to intensify. The European Union is edging closer to a ban on Russian oil imports after Germany, the bloc’s de facto leader, dropped its opposition to an embargo. The European Commission is due to present the latest sanctions package, which includes a provision for Russian oil imports, to the bloc members today.

Despite wide agreement on the oil embargo, it could still fail because it needs to be approved unanimously by all EU members. Consequently, it is likely to include exemptions for those that still oppose such a measure, most notably Hungary and Slovakia. What’s more, the oil ban is likely to take the form of a phase-out approach. Even so, Russian losses are set to deepen following the EU’s embargo. Russian oil production is already down by 1 mbpd from the pre-war level and losses are expected to more than double this month. This points to a widening supply deficit, which in turn will likely push oil prices higher.

As the market faces the prospect of an increasing shortfall in Russian oil supplies, OPEC+ continues to remain unmoved. The producer group meets tomorrow for its regular discussion of production. Expectations from analysts point to zero change in strategy, meaning OPEC+ countries are expected to greenlight another 432,000 bpd monthly increase for June. However, a large chunk of these supplies is not expected to materialise. From October 2021 through March 2022, OPEC output came in lower than the deal commitments, except for the month of February. And it was a similar story last month. According to a Reuters survey, OPEC produced 28.58 mbpd in April, meaning that OPEC’s 13 members produced only 40,000 bpd more than in March, which was substantially lower than its quota of over half of the agreed 400,000 bpd monthly increase in OPEC+ output.

So, several OPEC+ member states are struggling to meet their production targets. At the same time, Russian losses are set to increase. The upshot is that the OPEC+ quota gap is set to widen. In other words, the oil group’s compliance rate with production cuts is only going to increase. All of this has the makings of a greater than expected supply deficit over the coming months. The tightening supply backdrop bodes well for prices and should give oil bulls the upper hand, at the least in the short term. Simply put, there are currently more reasons to be bullish than bearish.