Dynamics have changed in energy markets as inventory levels and the geopolitical environment put pressure on margins

Last week, the oil market and its byproducts experienced a sell-off across the board due to several factors, ranging from geopolitical data to industry fundamentals. Traditionally, after a significant 8.2% rally, a pullback would not be surprising. However, last week’s -7.44% move, especially in trade flow activity, is quite worrying for oil bulls. This drop put WTI within striking distance of the 200-week moving average, a key historical technical level that must be held to avoid a potential further price decline. We will then discuss the technical landscape in more detail. Due to price action, changing industry dynamics, and significant geopolitical shifts, it is timely to re-evaluate the oil market.

Inventory situation

As you may know, commercial oil inventories in the United States have been steadily increasing following the brief seasonal peak in demand that faded in late September. Towards the end of September, subtle signs of demand destruction in some segments of the industrial industry began to emerge in macroeconomic data, and domestic production continued to rise to a record high of 13.3 million barrels per day (mbpd), leading to what is now referred to as a short-term “overinventory”. It is important to note that the 2023 production levels were the result of a resurgence in shale oil production, with the emergence of new techniques to improve extraction yields by targeting multiple layers and extending the productive life of wells existing. Large integrated energy companies reaffirmed their investment in shale operations through several mergers and acquisitions last year, targeting smaller producers with exposure to the Permian Basin.

Earlier in the year, inventory levels fell, but with the recent Arctic blast impacting much of the United States, the market cannot confirm whether this trend is weather-related or indicative of the industry starting to contain production levels. Seasonally, inventory levels tend to stabilize as refineries prepare for the summer season by replenishing their reserves of gasoline and diesel. In the short term, inventory building is bearish for crude oil prices, but the healthy spread between March/April and even May RBOB futures prices that existed through November last year could become profitable for some refineries in the coming months. weeks.

Next, we discuss the Strategic Petroleum Reserve (SPR). To the casual observer, SPR restoration is another key reason for price support, as the US still has around 300 million barrels to replenish to reach pre-distribution levels. However, the charging process is more complicated and strategic than it seems. Before the big drawdown, SPR stored mostly light, sweet crude, a mix abundant in the United States. The Energy Department has begun filling reserves with sour crude, a less common but important blend for heavy byproducts such as diesel and heating oil. This strategic shift is critical for long-term sustainability in the event of a geopolitical or weather crisis. The pace of SPR replenishment has been slow for some, limited to around 3 million barrels per month due to logistical constraints and maintenance work at reserve sites. Demand for sour crude and the lack of U.S. production of sour crude represent another bottleneck, making the SPR a consideration but not a major price driver in the coming months.

Let’s now move on to the global panorama. China has been a positive catalyst that bulls have been waiting for over the past 6 months, but its poor reopening efforts have disappointed many. Contrary to the mainstream narrative, China is growing, although not as fast as the market had hoped. Perhaps expectations were too high, as many forgot that the U.S.’s post-Covid reopening efforts were also less than spectacular. China has announced several stimulus packages to stimulate consumer spending and address issues in its real estate market. However, the excitement over these announcements was short-lived as the property market once again hit the headlines following a Hong Kong court ruling that Evergrande, China’s second-largest property developer by volume, must liquidate assets after failing to reach an agreement with foreign bondholders. This situation has already put pressure on the Chinese economy and could cause the expected residential and commercial real estate bubble to burst. With this looming over China’s future, oil markets priced in sluggish demand despite China increasing its oil import quota for the year.

Downward pressure this week came not only from China but also from the volatile nature of the API and EIA inventory reports. Two weeks ago, the United States experienced its first major cold snap of the season, which impacted energy operations across the country. The Bakken region has seen a reduction of 650,000 barrels per day in production due to infrastructure issues in North Dakota, along with challenges facing operations in the Gulf.

Geopolitical landscape

Over the past month the market has been alert to the escalation in the Red Sea, which has impacted shipping routes and increased shipping costs. However, the impact on oil transportation was minimal. While at first glance prices did not appear to factor in “geopolitical” risk, there was a glimpse into market sentiment on Thursday after Al Jazeera reported a ceasefire agreement between Israel and Hamas. This was later corrected to indicate ongoing talks, resulting in a $2 drop in crude oil prices. This is something to monitor in the coming weeks. If the ceasefire negotiations fail, we could see a small recovery that would price the return of the escalation premium in contracts. However, from a long-term perspective, this is a bearish development for crude oil and could continue to fuel speculative selling.

Another geopolitical event under the radar but worth monitoring is the warning by the Polish Armed Forces Operational Command of Poland of potential increases in military aviation activity in its airspace due to the Russia/Ukraine conflict, with necessary restrictions set from 5 February to 5 March. Military drones and artillery were observed crossing Polish airspace, indicating this could be a precautionary measure or a sign of growing tension along the border. The curve ball in this situation is the recent news that Russia is ready to discuss gas sales directly to the EU again as the transit agreement with Ukraine expires at the end of this year, which does not signal a wider expansion of the conflict, but at this point, anything is possible.

Strengthening of the US dollar

Since the beginning of the year, the dollar has progressively strengthened, traditionally putting pressure on almost all physical commodities. However, price action over the last two sessions signals a clear upward breakout following the FOMC meeting, regional bank problems starting to resurface, and ISM prices for both manufacturing and services becoming hotter than expected, rekindling the “flight towards quality trade”. Today, the dollar index surpassed the key 104 level, so volatility is to be expected.

Technical configuration

The year began with crude oil receiving strong upward demand, although open interest was contracting early in the move, indicating that short traders were offsetting their positions. The weekly charts highlight some key areas to focus on in the near term. The 200-week simple moving average has historically been a reliable support area in the oil market, and a breach of this key support level could indicate continued selling pressure. A key resistance level is the 200-day SMA, which crude oil rejected on January 29. Despite the recent downward pressure, volume eased on Friday, suggesting that sellers may be losing steam in the near term. Range-bound trading is common, so watch out for support at the $71 level and resistance at $78. Until these levels are broken, volatile and range-bound action is expected in the near term.

This article comes from an unpaid freelancer. It does not represent Benzinga’s reporting and has not been edited for content or accuracy.

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