Oil prices fell from their peak levels of over $120 per barrel for WTI in June 2022 to around $70 by now. Expectations by the Organization of the Petroleum Exporting Countries (OPEC) and the International Energy Agency (IEA) highlight concerns over global demand. At the same time, rising production of non-OPEC countries, mainly in North and South America, has offset OPEC+ production cuts. The bearish sentiment in the oil market persists; however, several factors could affect the oil price and put some upward pressure on it. Let’s break down the current crude oil environment and what it could mean for oil prices in the coming months.
The recent weakness in the oil market has been partly due to soft demand, primarily coming from China – the largest oil consumer in the world. The latest monthly reports by OPEC and IEA highlighted this issue in addition to hedge fund speculation and bearish market sentiment. China’s economy has slowed down as GDP figures have come softer than anticipated in the past several quarters. Moreover, the last IMF global report revises down China’s economic growth for 2024 to an annual rate of 4.8%. Despite the unfavorable outlook, some recent economic data still show that the direction of China’s economy isn’t clear; e.g., the latest retail sales report came better than expected. In addition, the Chinese government and central bank aren’t waiting for China’s economy to slow down. China will inject over 140 billion USD of capital into commercial banks, and the PBOC cut lending rates to shore up liquidity. These steps may provide some relief to the economy, which could, eventually, result in a pick-up in demand for oil. Nonetheless, for now, the negative market sentiment and uncertainty around the direction of China’s economy will not likely provide a backwind for the oil market. Besides oil demand dynamics, two other factors could influence oil prices: The US dollar and supply-side issues.
Many analysts and forecasters expected crude oil supply issues would contribute to the recovery of oil prices: The US Energy Information Administration (EIA), OPEC, and IEA expected the decision of OPEC+ to cut its production quota would raise withdrawal from oil inventories and raise oil prices. As a result, these agencies expected oil prices to rally to around $80 a barrel. These projections were correct because the OECD oil inventories have declined, but these withdrawals have not raised oil prices.
One contributing factor relates to the output of non-OPEC countries, which is on course to rise this year by 1.2 mb/ day, according to OPEC’s recent monthly report – and has partly offset the decline in output of OPEC+. These gains are mainly coming from the US, Brazil, and Canada.
However, supply could still be a factor in driving up oil prices due to the growing tensions in the Middle East that raise the odds of a broader conflict and could adversely affect crude oil supply – an issue that has slowly become a factor market participants have been considering.
For example, consider Iran’s attack on Israel in April and October 2024. The April attack did not seem to have much impact on oil prices, as seen in the chart below. However, the second attack on October 1 appears to have contributed to a sudden spike in oil prices (even though other factors could have also played a role, such as the rally of the US dollar). Even if these price gains were short-lived, they may suggest that the market is paying more attention than in the past to the possible ramifications of a flare-up in the entire region.
Crude oil and Iran’s attacks
Source of data: EIA
Besides the demand-supply dynamics, another critical factor is the US dollar. In recent weeks, it has been rising against major currencies as the US economy shows strength in its latest jobs and GDP reports, despite the FOMC’s decision to cut rates by 50 bp in the September meeting. Since then, markets have tapered their expectations and lowered their projections of future rate cuts. For example, right after the September meeting, the bond market priced in a possible 75 bp rate cut by December and two percentage points by the end of next year. In the recent market outlook in the bond market (see table below), the expectations have been revised to less than half a percentage point rate cut by December 2024 and less than 1.5% by December 2025. These changes have helped shore up the US dollar, which only provided some additional headwinds for oil prices. If a few economic data show signs of a slowdown (enough to persuade the Fed to slash rates more vigorously but not too much to raise concerns over oil’s demand), it could raise the chances of additional rate cuts, reverse the course of the US dollar, and raise oil prices. On the other hand, the result of the US elections may revise the course of US fiscal policy that could pressure the Fed to keep rates unchanged or even raise them.
Probability of rate hikes by FOMC, October 15
Source of data: CME
Probability of rate hikes by FOMC, September 19
Source of data: CME
In sum, the economic woes from China, the stronger US dollar, and the production boost of some non-OPEC countries left oil prices at $70. Several factors could change market sentiment, such as signs of recovery of the Chinese economy, the stockpile withdrawals starting to hinder the market, and US economic data suggesting some softness may raise the chances of more rate cuts from the Fed, thus weakening the US dollar, and rising tensions in the Middle East. In short, it seems that most of the downward risk has been priced into crude oil, which may suggest that the next surprise will be to the upside.