The oil market has experienced a retreat in bullish sentiment over the last few weeks, as shifts in geopolitical tensions have influenced the market. Notably, the anticipation of Israeli military actions, which are now expected to avoid critical Iranian oil infrastructure (though not with 100% certainty), has led to a recalibration of risk assessments.

Despite these geopolitical developments, underlying market fundamentals, including inventory levels and production rates, continue to influence price movements. There appears to be a balancing act between the continuously uncertain geopolitical landscape and concerns over an oil surplus in 2025.

Recent IEA reports suggest that OPEC must cut an additional 0.9 million barrels per day next year to balance the market. This is in contrast to the cartel’s strategy of gradually regaining market share and 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.

OPEC will continue to closely monitor market conditions and perform monthly evaluations of their planned production increase, adjusting the production scale as needed to stabilize prices within the mid-70-to-80-dollar range.

We anticipate the planned OPEC December 2024 production increase of 180,000 barrels will occur, which is likely looming in the consciousness of market participants trying to balance the bulls and bears.

However, even though Brent prices have retreated from their largest peaks during the height of the Middle East unrest in early to mid-October, we now see Brent crude prices trading in positive territory since opening on Monday this week, climbing by USD 3 per barrel over the last four days and currently trading at a strong USD 76.2. This returns to the September peaks before the worst escalation in the Middle East.

As zero Israeli retaliation has materialized and with less focus on vital Iranian oil infrastructure, investor sentiment has been impacted, with hedge funds and money managers reducing their long positions in major petroleum contracts. Specifically, there was a notable decrease in positions across Brent (down 28 million barrels) and WTI (down 12 million barrels), reflecting a, so far, relaxed approach to potential supply disruptions.

Yesterday evening, we also received a slightly bearish US inventory report from last week’s data. There was a sizeable increase in US commercial crude oil inventories, which rose by 5.47 million barrels. However, keep in mind that total inventories remain about 4% below the five-year average for this time of year, totaling 426.0 million barrels.

Notably, gasoline inventories also experienced a rise, increasing by 0.88 million barrels, yet still tracking approximately 3% below the five-year average. In contrast, distillate (diesel) inventories saw a decrease of 1.14 million barrels yet remain a very bullish 9% below the five-year average. Overall, total commercial petroleum inventories experienced an upward movement, adding 5.9 million barrels over the week. This is slightly bearish indeed, but likely not enough to counter the geopolitical uncertainties ahead.

As market participants monitor the fundamentals, the potential for a hard Israeli retaliation remains an important risk, with possible impacts on Iranian oil facilities still on the table. Such geopolitical risks are juxtaposed with fundamental calculations, such as the enforcement of sanctions and adjustments in OPEC+ production strategies.

In summary, while current market conditions suggest a greater stabilization of prices and concerns for a surplus in 2025 are holding back Brent prices from spiraling, the underlying risks related to geopolitical actions should weigh heavier. The more time that passes without any Israeli retaliation, the more likely the risk premium will fade. Yet, more time also means more Israeli preparation, and the retaliation will likely be well-planned with significant consequences for Iran. In essence, it takes courage to maintain a short position in the current market. Again, the continuous potential for upside risks outweighs the downside risks.

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.