Oil Falls 2% as Supply Fears Ease; What's the Next Price Driver?

On Tuesday, Oct 28, Oil prices plunged for the third straight day. One of the main reasons behind the fall was linked to the geopolitical supply fears and fresh production prospects. As a result, Brent crude futures declined by 83 cents (1.26%) to $64.79 a barrel. Also, the U.S. West Texas Intermediate crude futures fell 75 cents (1.22%) to $60.56 (MSN News). This has led to a marked pessimism over the hike in potential OPEC+ output, which has overshadowed typically bullish news. There was also a major breakthrough in the US-China trade talks and an astonishingly large draw in the US crude inventories.

The news has led the crude oil markets into a classic tug-of-war. Here, on one side, there are bullish demand signals, and on the other, bearish supply chatter. Last week, the Brent and WTI prices saw their most significant weekly gain since June (Reuters). However, fear of new US sanctions on Russia crippling global supply mainly drove this. Now, the premium is rapidly evaporating, and there are so many conflicting drivers. A crucial question for investors is: which force will win out, and what does this mean for the oil prices heading into winter?

Why Are Russian Sanction Fears Fading?

It was the fear of a supply crunch that pulled the market significantly last week. The Trump administration decided to sanction Russia's two largest energy firms, Lukoil and Rosneft (InvestingDotCom). This was mainly over the war in Ukraine. It caused traders to brace for a major disruption, since Lukoil alone accounts for around 2% of global oil output (Reuters). However, this week, that fear has been significantly deflated by a series of new developments.

But why is the market no longer pricing in a worst-case scenario?

• The "German Waiver" - The US government has provided written assurances to Germany. This was about clarifying that the German business of Rosneft would be exempt from the sanctions since these assets are no longer under Russian control. This "wiggle room," as one analyst called it (Reuters), has given the impression that the sanctions might be more targeted and less catastrophic to global supply than initially dreaded.

• IEA Calms the Waters - Fatih Birol, the executive director of the International Energy Agency (IEA), publicly stated that the effect of sanctions on oil-exporting countries will rather be "limited." (The Economic Times) He pointed to the surplus capacity available in the market that can be tapped to offset potential losses.

• The Indian Response - The sanctions have had a tangible impact on buying patterns. It’s reported that Indian refiners have halted all new orders for Russian oil (Reuters). India is a major buyer of seaborne Russian crude. Therefore, this "wait and see" approach from India is of considerable importance. It has also created a pocket of uncertainty and redirected tankers. But the market is betting that this void will be filled by other producers.

Such a rapidly unwinding "sanction premium" has put immediate downward pressure on prices. So, the question now is, who will fill the gap left by hesitant buyers like India?

Is OPEC+ About to Open the Taps?

The volume isn’t massive, but the signal it has sent is powerful. As suggested, the OPEC+ is shifting its strategy from price support to reclaiming market share. As Andrew Lipow, president of Lipow Oil Associates, noted, this rising OPEC+ output could "help offset any curtailment to Russian barrels," effectively neutralising the sanction threat (FX Street). This potential supply increase can now be the single largest factor weighing on market psychology.

Can Bullish Demand News Stop the Slide?

There's positive news that we’ve all ignored. On any typical day, these two major developments would have sent prices soaring. However, they were completely overshadowed by the supply-side chatter.

1. US-China Trade Truce - This is major positive news for global demand. Cooling trade tensions can be a powerful antidote to fears of a global economic slowdown. This should’ve, in theory, led to a boost in the outlook for oil demand.

2. Massive US Inventory Draw - The API (American Petroleum Institute) has reported a humongous draw in US stockpiles for the week ending Oct 24. This can signal robust domestic demand.

This shows that the market’s focus has fundamentally pivoted. Traders are no longer worried about a lack of supply; they are now worried about a glut.

Source

The Economic Times
FX Street
Reuters
InvestingDotCom
MSN News
Yahoo Finance