In mid-to-late August, the European energy crisis intensified. However, compared with natural gas, where supply shortages are expected to be very strong, the increase in international crude oil prices is still relatively weak. The global economy is currently facing the risk of slowdown or even recession, but unlike previous recession cycles, this round of recession is occurring in a high-inflation environment, and the cause of high inflation is not just the demand level, but more supply disruptions. Therefore, during this period of economic slowdown or recession, affected by factors such as the geopolitical crisis (Russian-Ukrainian conflict), supply chain disruptions, and shrinking capital expenditures, crude oil prices may fall relatively slowly or lagging behind, and it is not even ruled out that supply concerns intensify. Pulse type rebound. From the perspective of monetary policy and economic cycle, there is no support for a sharp rebound in crude oil prices, but supply disruptions support the resistance of crude oil prices to decline.
Monetary tightening dampens demand
From the perspective of commodity pricing mechanism, it depends on the relationship between supply and demand, and monetary policy affects demand. Tight monetary policy will inevitably inhibit the expansion of commodity demand, and the demand for energy such as crude oil is no exception.
On August 26, at the high-profile annual meeting of global central banks in Jackson Hole, Federal Reserve Chairman Powell delivered a hawkish speech, once again reiterated that “inflation will not stop and interest rates will continue to rise” and said that raising interest rates will be restrictive to economic growth. There will be no rush to cut interest rates after reaching the level. This is a very clear push back against market expectations for a Fed pivot in 2023. This means that at the upcoming interest rate meeting, the Fed will continue to raise interest rates significantly to place interest rates above the neutral level, and maintain interest rates above the neutral level for a period of time – possibly until the whole of next year. . There is no doubt that the Fed is far from done with its efforts to reduce inflation, with the final rate priced in the swap market at 4%.
Speaking at the annual meeting of global central banks in Jackson Hole, Powell said that it is allowed to curb inflation at the expense of an appropriate slowdown in economic growth, especially through cooling demand to achieve supply and demand matching, because the current high inflation in the United States is indeed a result of strong demand and The product of supply constraints, and the Fed’s tools mainly work on aggregate demand. Therefore, the Fed will continue to allow the U.S. Treasury yield curve to continue to invert.
What is special about this round is the complexity of short-term inflation, such as supply factors and structural shortages in the job market, which may make the entire inflation last longer and not be easy to fall back quickly. At this time, the high-pressure momentum of monetary tightening needs to be maintained.
As for the US inflation index falling back in July, the entire inflation trend cannot be predicted based on changes in the inflation index in a single month. Powell stated that under the current circumstances, with inflation well above 2% and the job market extremely tight, even after reaching the expected level of long-term neutral interest rates, it is still not time to stop or pause.
From the perspective of trading strategies, historical experience shows that if we see a flattening or even inversion of the interest rate curve, a turnaround in inflation, and expectations of an economic slowdown, we can lay out the Fed’s next round of easing trading strategies. However, the situation this time is different. The current short-term inflation is too far from the central bank’s target and is different from the low inflation environment during monetary tightening from 2016 to 2019. Therefore, for crude oil, demand will still be suppressed.
From the perspective of U.S. crude oil demand, tight monetary policy has exerted a certain negative drag on the economy, with indicators such as real estate, household consumption, and manufacturing all slowing down. According to OECD estimates, in the second quarter of 2022, global crude oil demand will be approximately 98.56 million barrels per day, a decrease of 0.8% from the first quarter and an increase of only 3.1% from the same period last year. According to data released by the U.S. Energy Information Administration (EIA), U.S. gasoline demand fell sharply by 914,000 barrels per day in the week ending August 19, the second largest decline so far in 2022; the four-week rolling basis of demand also fell by 2.24%. to 8.86 million barrels per day, only slightly higher than the same period in 2020.
The picture shows the estimated global crude oil consumption and year-on-year growth rate
Supply disruptions haven’t gone away either
The current supply disruption in the international crude oil market comes from the restriction of Russian crude oil exports due to the conflict between Russia and Ukraine, and OPEC countries such as Saudi Arabia are unwilling to see Iranian crude oil flow into the market. Therefore, OPEC and others may reduce production after oil prices fall to a certain extent in order to compete for international crude oil. Pricing power.
According to data released by OPEC’s monthly report, in July 2022, OPEC crude oil production increased by only 216,000 barrels/day compared with June. Among them, Saudi Arabia’s increase in production that month was only 158,000 barrels/day, and the year-on-year growth rate slowed to 13.7%. The year-on-year growth rate in June was as high as 18.5%. On August 22, Saudi Energy Minister Abdulaziz bin Salman warned that “extreme” volatility and lack of liquidity mean that the crude oil futures market is increasingly disconnected from fundamentals, which may Force OPEC+ to take action to reduce production. As Iran’s long-term rival in the Middle East, Saudi Arabia has been critical of the Iran nuclear deal reached during the Obama administration. In addition to “demonstrating” against the United States and Iran, Saudi Arabia also hopes to use the new production reduction agreement to stabilize the duopoly with Russia in OPEC+ and maintain high oil prices in the market. Calculated based on CME Group’s OPEC Watch ToolThe probability of OPEC meeting reaching an outcome is 68.32% in September, while the probability of OPEC maintaining crude oil production or slightly increasing production is 31.49%, and the probability of significantly increasing production is less than 1%.
The picture shows the probability of the outcome of the September OPEC meeting calculated by the CME Group’s OPEC Watch Tool (data as of August 29)
In addition, there are still difficulties for Western countries to reach a new nuclear agreement with Iran. Iran’s nuclear negotiations are once again in a “tug of war”. Iran said it will take at least September 2 to respond to the Biden administration’s reply to the EU text, and that the restart of nuclear agreement negotiations will be extended until September.
It is worth noting that the release of US strategic reserves has been completed, which may lead to a tightening of international crude oil supply. Data released by the U.S. Energy Information Administration (EIA) show that in the week of August 19, U.S. overall oil exports were 11.076 million barrels per day, a record high; U.S. strategic petroleum reserves fell by 8.1 million barrels, the largest weekly decline in history. The size of the strategic oil reserves that Biden urgently released is 180 million barrels of oil. Relevant agencies estimate that after Iran reaches a new nuclear agreement, about 93 million barrels of Iranian crude oil and condensate will flow to the market. Assuming that the Iran nuclear agreement is finally reached, it will still be unable to hedge against the United States. The gap left after the release of strategic petroleum reserves ends.
In short, the current international crude oil prices may still maintain a high and oscillating trend. From a demand perspective, the global economy is likely to be in a slowdown or recession cycle in the next 1-2 quarters, and the Fed’s monetary tightening will further suppress demand. However, since interference factors in crude oil supply also exist, it is unlikely that there will be a large-scale surplus of crude oil. It is estimated that the global crude oil surplus will be only 1.2 million barrels per day in June 2022, and there is no risk of a sharp drop in oil prices in the short term. Investors can use CME Group WTI crude oil futures (contract code: CL) to seek swing trading opportunities. In addition, for the OPEC meeting held on September 5, WTI crude oil weekly options ((LO1, 2, 3, 4, 5) are also a very suitable tool to manage oil price fluctuations at that time, because the expiration date of the option contract is every Friday, so investors can choose contracts with expiration dates on the two Fridays before and after the OPEC meeting, that is, September 2 or September 9 for risk management. For small investors with limited funds, CME Group We also provide micro WTI crude oil futures (MCL) and micro WTI crude oil weekly options (MW1, 2, 3, 4, 5). Compared with the standard contracts mentioned above, the size of micro contracts is only one-tenth and the required margin is Lower and more suitable for small investors.
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