Commodities Oil's rally can go further

The move came after Saudi Arabia and Russia announced an extension of their production cuts on Thursday. Saudi Arabia said it will continue its unilateral 1 million barrels per day (mbpd) output cut into September, adding that the cut can be extended or deepened if conditions warrant it. Russia is also expected to extend its export cuts into next month (0.3mbpd), although at below August’s levels (0.5mbpd).

Added momentum came from US data showing the largest-ever drawdown of crude inventories last week, with holdings contracting by more than 17 million barrels. A combination of technical and fundamental factors has pushed up oil prices since the beginning of July. On the technical front, Brent broke above the 200-day moving average and momentum traders switched from short to long trades, covering elevated short futures and option positions. On the fundamental side, OPEC+’s voluntary production cuts and recent unplanned production outages during the demand-heavy Northern Hemisphere summer months are also supporting oil prices. Given the constructive forces we see for crude in the coming months, we remain positive on oil and continue to expect prices to rise to USD 90/bbl by end-2023 amid demand-supply mismatches.

On the demand side, prospects remain solid. Oil demand has been robust at above 102 million barrels per day in July, and is set to breach 103mbpd in August for the first time, driven by emerging Asia—mostly from China and India—as well as Brazil and the Middle East. Together, we expect these to offset the underwhelming demand from advanced economies.

Supply to remain tight. OPEC+ crude output hit a one-year low in June, and production in July was also likely considerably lower due to Saudi Arabia’s extra voluntary cuts and temporary production outages in Mexico, Kazakhstan, and Nigeria.

Crude exports from OPEC+ hit a 22-month low in July as well, sinking by more than 0.9mbpd in the first 30 days of the month versus June levels. Exports by OPEC+ allies, meanwhile, also fell by more than 0.6mbpd in the first 21 days of July versus June, driven by lower crude exports from Russia, according to Petro-Logistics. Lower exports have started dragging down inventories. We expect supply to remain tight in the coming weeks, given the extension of Saudi- and Russian-led production and export cuts. Libya also remains a wildcard, with some political stakeholders threatening to stop production in September if their requests are not met.

Oil markets to remain in deficit, pushing up prices. In our view, the result of this supply-demand picture is likely to be a market deficit of around 2mbpd in July and August, versus around 0.7mbpd in June. We also previously estimated that if the Saudis extended their 1mbpd oil cuts, as has happened, September could see another deficit of more than 1.5mbpd.

So, we retain a positive outlook for oil prices and forecast Brent to move to USD 90/bbl by end-2023. Risk-taking investors are recommended to add long exposure via first-generation indexes or longer dated Brent contracts, or to sell Brent's downside price risks. We are also most preferred on the US energy sector.

Main contributors - Solita Marcelli, Mark Haefele, Giovanni Staunovo, Krishna Goradia, Christopher Swann

Original report - Oil's rally can go further, 4 August 2023.