A Cautiously Bullish Outlook For Oil

Crude Oil Fundamental Analysis

Nowhere is this notion more prevalent than through the lens of global crude oil inventories. As we can see below, observable crude inventories on land, at sea and in-transit have started 2024 at much lower levels than anything seen over the past five years.

However, as I noted within my recent oil market update, we continue to see a disparity between crude oil inventories and total crude and petroleum inventories, of which the latter includes refined products, notably gasoline, distillate and jet fuel.

While crude oil inventories commenced 2024 below their seasonal averages and below 2023 levels, total crude and petroleum inventories did not. Meanwhile, gasoline inventories saw significant builds to close out 2023 such that they began 2024 with inventories in-line with seasonal norms. And finally, although distillate inventories still remain well below seasonal averages, they have started 2024 at higher levels than 2023.

The initial crude oil draws we saw to start the year were partly a function of the extreme weather we saw in the northern hemisphere during January, which took large parts of US oil production briefly offline, as well as greatly impacting refining activities. In addition, this January cold blast also saw a drop in gasoline and diesel demand as road traffic temporarily took a hit, resulting in builds in gasoline and distillate inventories through January.

In the past few weeks however, as US oil production has rebounded, we have seen the opposite occur. Crude oil has seen builds such that in the US, inventory levels are now above seasonal averages, while total petroleum inventories have seen draws, as refined product draws have exceeded inventory builds. Total crude and petroleum inventories now sit below seasonal averages.

What’s important to note here is that throughout January, draws in crude oil inventories (bottom chart below) were more than enough to offset the builds in refined products, resulting in persistent below seasonal draws in total crude and petroleum inventories (top chart below). Given my preferred means to assess the inventory spectrum of the oil market is through the lens of total crude and petroleum inventories, this is most definitely a bullish dynamic. And, so long as product draws continue to offset any potential builds in crude, the inventory picture remains bullish in my book.

Alas, as we can see above, this has not been the case over the past two to three, and may not be the case for the next week or two either. The recovery in crude oil production has occurred at a faster pace than the recovery in refinery demand, as refinery throughput remains down, headlined by the outage of BP’s ~400,000 barrel p/d refinery facility in Whiting, Indiana.

That this is also occurring amidst refinery maintenance season has led to refinery crude throughput and utilisation rates drop to their lowest levels for this time of year in over half a decade. As refiners are the primary consumers of crude oil, a drop in refinery utilisation coupled with a bounce back in crude production is a combination for builds in crude oil inventories, which is what we have seen this past week and will continue to see for the next week or two.

Unless gasoline and inventory demand are such that we see draws in these refined products offset builds in crude, this is a headwind the oil market will need to face for the next couple of weeks, and could limit short-term upside.

However, not only has refinery demand likely reached a bottom, but it will recover as refineries come back online in the coming weeks as maintenance and repairs are completed.

Most importantly, what will determine the incentives and level of demand rebound wee see from refiners in the immediate term will be refinery margins (i.e. crack spreads). Up until recently, both the 321 crack and refined product cracks were holding up strongly, but we unfortunately did see a drop in the 321 and distillate cracks over the past two weeks, confirming the short-term drop in underlying demand.

But, as we can see above, gasoline cracks have soared this past week, which could well be indicating the fall in refining margins is over. But, unless we see crack spreads continue to firm from here, move higher in crude may be due for a period of rest.

Meanwhile, the futures term structure for both WTI and Brent is indicating the oil market remains tight, as evidenced by their current state of backwardation (which is being confirmed by backwardation in Brent CFDs and DFLs). Importantly, this backwardation is continuing to tighten at the front of the curve, as we can see below.

In addition, both price and demand seasonality remain positive. This is true of both crude oil and refined products, with seasonal demand for refined products set to rise as we exit the northern hemisphere winter during a time where both gasoline and distillate inventories are now below their seasonal averages.

While we also continue to see OPEC+ implement their production cuts with relatively high levels of compliance. I would expect this continue for at least the next few months given the tightness in the market we are seeing.

Crude Oil Price Forecast

In addition, OPEC+ remains well incentivised to keep a lid on production while speculators are still positioned bearishly as they currently are, as we can see below. If the tightness in the market continues and we see a prolonged combination of backwardated term structure, robust crack spreads and overall petroleum and crude inventory draws, speculative short covering could easily fuel oil prices into the mid-to-high $80s in short order.

Thus, as it stands, while there are short-term headwinds present stemming from a temporary drop in refinery utilisation and the recent drop in refinery margins, the oil market continues to look much tighter than expected during the first quarter of 2024.

The next move in oil will probably be dependent on how quickly refinery demand comes back, which itself is likely to be a function of crack spreads. And, if we see refined product inventory draws outpace any inventory builds (which hasn’t been the case the past few weeks), oil prices will remain well supported.