Crude Oil Market Divergence

State of the Oil Market

The International Energy Agency (IEA) recently reported a decline in global oil supply by 230,000 barrels per day to 101.1 million barrels per day in April, with expectations of steeper losses in May due to Canadian wildfires and additional production cuts by some OPEC plus members. Surprisingly, despite these supply disruptions, oil prices have not surged above $100 per barrel. This is surprising as the oil demand is only expected to rise as the IEA has raised its oil demand forecast, projecting a year-on-year rise of 2.2 million barrels per day to an average of 102 million barrels per day in 2023.

As global oil inventories decline, the oil market anticipates a historic under-supply in the second half of this year, which raises uncertainty regarding the fulfillment of expected demand. Notably, in March, global oil demand reached a record high, driven by increased demand in China and the United States, resulting in a substantial surge of three million barrels per day. However, there exists a significant divergence between the price of oil futures contracts and the underlying supply-demand fundamentals.

Crude Oil Market

This divergence in the crude oil market has raised concerns as the WTI futures curve demonstrates a further divergence, despite fundamental factors indicating a rise in oil prices. It's worth noting that a Contango price structure is considered typical. This structure takes into account the expenses associated with storing and carrying the commodity over time. For instance, if you were to purchase crude oil today with the intention of selling it later, you would incur costs such as transportation, storage fees, and the interest you could have earned on the money tied up in inventory. As a result, it is expected that the future selling price would be higher to compensate for these expenses. When issues related to physical oil supply gain widespread attention, it typically signifies a positive market sentiment or a bullish outlook. The persistence of this situation, combined with the potential resurgence of the dollar bull market, has prompted questions about the potential occurrence of a deflationary recession.

The Dollar Bull Market

While China’s reopening has had an impact in the increase in oil demand, the recent release of underwhelming economic data from China has further confirmed suspicions that the country is facing significant challenges, consequently placing the rest of the world in a delicate position. This has resulted in a sharp increase in the exchange value of the US dollar, which could potentially contribute to a deflationary recession.

Japanese government bond yields, instead of rising as expected, reached a plateau around January, indicating a potential increase in the cost of acquiring dollars, especially in the Asian region. The economic conditions in China also heavily impact the Korean won and Indian rupee, leading to tight availability of dollars for these currencies as well. The Reserve Bank of India finds itself compelled to supply dollars at a price that the rear dollar market seems uninterested in, indicating that obtaining dollars has become increasingly challenging. As a result, the global economic situation has become increasingly precarious and hazardous, with the potential for a deflationary recession being factored into interest rates approaching zero.

Consumer Sentiment Drops

According to the University of Michigan's preliminary estimate for May, consumer sentiment dropped to 57.7, hitting the lowest level since November and registering a decrease from the previous month. The expectations index, reflecting consumers' future outlook, also experienced a decline from 60.5 in April to 53.4. Similarly, the IBD/TIPP index witnessed a nearly seven-point drop, falling from 48.2 to 41.6. These unexpected declines raise alarms as analysts had predicted an upward trajectory for both indexes. The decrease in consumer sentiment suggests that American households face difficult choices in balancing their family's desires and needs.

For more analysis on these topics, check out these articles:

Josh Young: Large Amount of New Oil Futures Contracts Go Short While Oil Fundamentals Improving?

Crude flips again just as retailers warn and business sales drop.

The dollar isn't crashing, it is surging again and at the worst time.

May reports show consumers, small businesses facing big trouble.

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