Brent crude falls back as day by day goes by with no Israeli retaliation. Market focus returns to concerns for surplus in 2025. Brent crude fell 7.6% last week following a rally to USD 81.16/b the week before when it felt like a retaliatory attack by Israel on Iran was imminent with all targets possible. Israel has promised that ”Iran will pay” for its attack on Israel on 1 October when it fired 200 ballistic missiles at Israel.

But days passed by and no retaliation happened. Fears that Israel will go after Iranian oil installations and nuclear facilities also seems to have faded. Biden has urged Israel to not hit such targets. Israel has said that it will make its own choices so it is still an open risk that Israel could indeed hit Iranian oil installations. 

Last week we had yet another report from the IEA where it predicts that OPEC must cut yet another 0.9 mb/d in 2025 to keep the market in balance. That keeps the fear going for lower oil prices in 2025. All in all Brent fell back 7.6% last week to a close on Friday at USD 73.06/b.

This morning it is back up to USD 73.3/b (+0.4%) which is not much and less than the 1% gain in industrial metals. So most likely it has very little to do with increased fears for an Israeli retaliation.

To us it seems like close to certain that Israel will indeed retaliate at some point. Likely hard and forceful and not a muted retaliation like in April. Leaked US intelligence documents over the weekend show rather extensive Israeli preparations for a retaliation on Iran involving three Israeli airfields including F-15s and refueling aircrafts. So market today most likely also thinks that the Israeli retaliation will come and a hard one as well. If so it will likely lead to yet another re-retaliation by Iran with a risk for spiraling effects which in the end could involve Iranian oil installations etc., etc.

But as long as nothing happens on a day to day basis, the oil price falls back with market focus circling back to concerns over a surplus of oil in 2025 where OPEC needs to cut another 0.9 mb/d to keep it in balance according to the latest report from the IEA. Though only 0.7 mb/d if FSU production is unchanged. OPEC+ planning to add barrels to the market from December onward makes that look even worse of course.

From backwardation-market in 2022/23/24 to contango-market in 2025? Over the past three years the oil market has been running tight. Tight on products and tight on crude. The long-dated Brent crude five year contract, or the 60 month contract, has been very stable at close to USD 70/b. The front-end Brent crude contract however has traded at a premium of USD 28/b, USD 15/b and USD 12/b for 2022, 2023 and 2024 respectively versus the 60 month contract.

If the oil market next year flips to a surplus with rising inventories then the market should naturally flip to a contango-market. The implication of that is that the front-end Brent contract will trade at a discount to the longer dated Brent price. The Brent 1 month price would then typically be USD 70/b (long-dated 60mth price) minus some discount of maybe USD 5-10/b. Implying a Brent 1 month price of USD 60-65/b. This is what the oil bears are eyeing for 2025 and why we have seen such overly bearish positioning lately.

Counter to such a development would be possible damage to Iranian oil supplies due to the forthcoming Israeli retaliation. Or in the  following re-re-re-re-retaliations after that. Or that Donald Trump is elected president and more strictly enforces sanctions on Iranian oil exports thus making room for more exports from the rest of OPEC+.

Brent crude 1mth contract minus the 60mth contract. Market shifting between contango-market (negative) and backwardation-market (positive).

Brent crude 1mth contract minus the 60mth contract. Market shifting between contango-market (negative) and backwardation-market (positive).

Brent crude prices have traded sideways since opening on Tuesday, consistently hovering around USD 74.2 per barrel for three consecutive days. However, since yesterday evening, prices have risen by USD 0.5 per barrel and are currently trading at USD 74.5. This increase primarily reflects core market fundamentals, and another bullish US inventory report released yesterday at 16:30 CEST.

The highly anticipated Israeli retaliation remains muted for now, easing the risk premium and reducing the severe tensions in the Middle East. However, the conflict continues: Israel’s Foreign Minister confirmed yesterday that Hamas leader Yahya Sinwar had been killed by Israeli forces in Gaza.

Media reports suggest that the US might use this opportunity to attempt to broker an end to the fighting, although Netanyahu emphasized in a speech yesterday that the conflict is far from over. Consequently, markets will remain volatile pending further developments.

Independently of the scale and strategy of the Israeli retaliation, we may currently be witnessing a shift in the oil market. The focus is moving from widespread fear of impacts on critical Iranian oil infrastructure to an expectation that the US will enforce sanctions on Iranian oil exports more strictly post-US elections. Both scenarios could lead to reduced Iranian oil production in 2025, thus potentially balancing the oil market and allowing OPEC+ to return barrels to the market without significantly lowering prices.

In recent years, the US has been reluctant to impose strict sanctions on Iranian oil exports to avoid driving up prices. Now, the situation has changed. Should Iran’s entire oil export capacity be disabled, the global market would lose roughly 2 million barrels per day of Iranian crude and condensate. Yet, with OPEC+ holding nearly 6 million barrels per day in spare capacity – with Saudi Arabia alone capable of boosting production by nearly 3 million barrels per day – the global oil supply remains robust, making it easier to enforce strict sanctions on Iran.

However, any significant reduction in spare capacity would naturally diminish the global balancing buffer and potentially elevate oil prices in the future. Thus, regardless of the situation, ongoing tensions in the Middle East are likely to persist, with a higher probability of oil prices trending upward rather than downward.

In terms of fundamentals, the latest US DOE report revealed a bullish drawdown of 2.2 million barrels in US commercial crude inventories. Currently, at 420.5 million barrels, US crude oil inventories are about 5% below the five-year average for this time of year.

Gasoline and distillate inventories also decreased by 2.2 million and 3.5 million barrels, respectively, both significantly below seasonal averages. Total commercial petroleum inventories decreased by 7 million barrels last week, indicating continued tightness in the US market.

US refinery inputs averaged 15.8 million barrels per day, a slight increase from the previous week, with refineries operating at 87.7% capacity. Gasoline production decreased to 9.3 million barrels per day, while distillate production dipped to 4.8 million barrels per day. Meanwhile, there was an uptick in implied demand for total products, up nearly 3% compared to the same period last year. Over the past four weeks, gasoline products supplied averaged 9.0 million barrels a day, up by 5.4% from the same period last year. Distillate fuel product supplied averaged 4.0 million barrels a day over the past four weeks, up by 0.2% from the same period last year. Jet fuel product supplied increased by a substantial 10.4% compared with the same four-week period last year.

In summary, while we continue to see a reduced geopolitical risk premium, more upside potential remains. The ongoing tight fundamentals in the US also support this view. Hence, although prices have stabilized, the potential for upside risks outweighs the downside, supporting a short-term buy recommendation.

Brent crude prices have declined for a third consecutive session, now plummeting by a substantial USD 3.1 per barrel since Monday’s close. Prices fell from USD 77.7 in the evening to the current USD 74.5. This decrease primarily reflects the easing tensions in the Middle East and the reduced likelihood of impacts on critical Iranian oil infrastructure.

Retaliation from Israel remains highly anticipated, yet its potential effect on energy infrastructure is now being questioned. Reports suggest that Israel may avoid targeting Iran’s oil facilities, alleviating concerns over major supply disruptions. Israeli Prime Minister Netanyahu has shown a preference for striking military sites rather than oil or nuclear facilities, as part of ongoing discussions with the Biden administration amidst the current turmoil.

The oil market has been notably volatile due to escalating tensions in the Middle East, exacerbated by the pending Israeli response to the Iranian missile attack on October 1. However, the anticipated non-disruptive retaliation against Iranian oil infrastructure is shifting market focus back to economic slowdown concerns in major economies, including China, thereby exerting downward pressure on oil prices.

Moreover, the absence of new stimulative measures from China’s Finance Ministry has tempered expectations for a boost in crude consumption in the world’s largest oil importer.

Complicating the market landscape, OPEC recently adjusted its demand growth projections downward for this year and the next, marking the third consecutive cut. OPEC now forecasts oil demand in 2024 and 2025 to be 104.1 million barrels per day and 105.7 million barrels per day, respectively, a decrease from previous estimates of 104.2 million and 105.8 million barrels per day.

Despite these projections, OPEC+ remains committed to increasing production by 180,000 barrels per month starting December 2024, culminating in an increase of 2.2 million barrels per day by December 2025. Nonetheless, we anticipate that the cartel will continue to closely monitor market conditions and perform monthly evaluations, potentially adjusting the production scale to stabilize prices within the mid-70-to-80-dollar range. We maintain confidence in the planned December 2024 production increase of 180,000 barrels, which currently places downward pressure on global oil prices as winter approaches.

However, it’s important to note that the risk of price spikes has not been entirely eliminated. Ongoing geopolitical risks, particularly concerning Iran, remain central to the market. The potential for Israeli retaliation continues to mitigate any significant downside in oil prices. Israel’s strategic calculations could be influenced by the upcoming US election on November 5th, as geopolitical alignments could shift, potentially impacting the timing and nature of military actions (read more: Benign macro fundamentals, geopolitical risks). Despite US discouragements against striking Iranian oil infrastructure, recent dialogues between Netanyahu and Biden do not guarantee the avoidance of such actions.

With this context, we continue to perceive substantial upside risks if the conflict escalates further and affects energy infrastructure. Although prices have declined, the potential for upside risks far outweighs the downside, supporting our recommendation to buy on these dips.