An Oil Supply Deficit Is Looming, And Traders Couldn’t Care Less

When Saudi Arabia announced at the June OPEC meeting that it will reduce its oil production by 1 million barrels daily, traders basically brushed it off.

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- The International Energy Agency (IEA), OPEC, and the U.S. Energy Information Administration all forecast a tightening oil supply in the second half of the year.

- Standard Chartered Bank's latest Commodity Roadmap indicates that the global oil market is already in deficit.

- Traders' reactions remain largely muted, as they continue to focus on macroeconomic factors like China's economic recovery and U.S. inflation rates.

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When Saudi Arabia announced at the June OPEC meeting that it will reduce its oil production by 1 million barrels daily, traders basically brushed it off.

When it announced it would extend these cuts through August, with Russia saying it would cut its oil exports by half a million barrels daily, traders brushed that off, too.

Analysts have been warning that a supply crunch was on the way but again, market players have largely ignored these warnings. Now, the warning signs are flashing brighter.

The International Energy Agency, which is not a big fan of oil demand, said earlier this week that despite China's uneven recovery, demand for crude on a global scale was resilient enough to lead to tighter supply in the second half of the year.

"Even in sluggish economic growth, China and other developing countries' demand is strong," IEA head Fatih Birol told Reuters, adding that "Taken together with the production cuts coming from key producing countries, we still believe that we may see tightness in the market in the second half of this year."

The IEA has been saying supply will tighten in the second half of the year for months now. So has OPEC. And yesterday, so did the U.S. Energy Information Administration.

In its Short-Term Energy Report, the EIA forecast demand for oil will exceed supply globally in the second half of the year. What's more, the EIA expects supply to extend its decline over the next five quarters.

The latest to forecast a market in a deficit was Standard Chartered. In the latest edition of its Commodity Roadmap, the bank said it expected demand for oil to actually continue increasing over the next few months, hitting an all-time high in August. As a result, prices will likely shoot up.

StanChart noted an important change in what will drive oil supply levels in the next few months. For now, the main driver has been action on the part of oil-producing nations. In other words, supply control has been key. In the second half of the year, however, the bank expects demand to take the upper hand.

That's not all, either. The global oil market is already in a deficit, according to Standard Chartered analysts. That deficit stood at around 1 million barrels daily in June, and this month it is seen at the same level.

In August, however, that 1-million-bpd gap is seen widening to 2.8 million barrels daily in August. It will then narrow a bit to 2.4 million bpd in September, StanChart said.

It will certainly be interesting to watch how traders respond to all these warnings for tighter oil supply. It will also be interesting to see how long they would continue to ignore them as they remain focused on macro factors.

In fairness, when OPEC and the IEA made their latest forecasts earlier this week, traders reacted by turning bullish, and prices climbed higher. Yet as so many times this year, they could yet retreat on any report saying China's post-pandemic recovery is taking longer than expected or that U.S. inflation is still higher than the Fed is comfortable with.

Indeed, the Bureau of Labor Statistics is releasing the latest monthly consumer price figures for June later today. Analysts expect inflation to have slowed on a monthly level from 4% to 3.1% but to have remained much higher on an annual basis, with the difference at 5.3%. If these figures are confirmed by the official report, chances are the latest oil price rally will fizzle out pretty quickly.

The market does not seem to care too much about what energy analysts call destocking, either. Energy Aspects' Amrita Sen wrote in an op-ed for the Financial Times this month that physical oil traders have been selling their inventory due to the higher costs of keeping it. And the higher costs are due to central banks' rate hiking spree.

"In recent months oil has traded as a 'show-me' commodity, i.e., traders seem to have preferred to wait for deficits to happen rather than take a position on the basis of projected deficits," Standard Chartered analysts wrote in their commodity roadmap. "We think the point when significantly tighter fundamentals should show clearly is now imminent."

It certainly looks that way. On the one hand, there is Saudi Arabia cutting production, demonstrating that OPEC is not giving up on higher prices, whatever the market's reaction to its actions so far. There is also Russia and the first signs of declining export volumes, as reported by Bloomberg on Tuesday.

On the other hand, there are many demand reports from various agencies, but most recently, the IEA and the EIA, which all emphasize the resilience of oil demand in the face of various challenges such as rising consumer prices in key markets and a now chronic worry about a global recession.

In that context, price volatility is not only heightened, it is also skewed to the upside. And the shock could be quite substantial because of the state of preparedness of many market players who watch the macro picture and ignore the fundamentals.

By Irina Slav for Oilprice.com / Jul 12, 2023