Market Analysis

Crude oil markets are facing increasing downward pressure, with prices breaking down, signaling potential further weakness ahead. In a recent note from BCA Research dated Friday, analysts highlighted several factors contributing to the recent drop in oil prices, warning that the worst may not be over.

Investors are being advised to scale back their exposure to oil, as market fundamentals suggest a continued price decline over the next six to nine months.

A key driver behind the fall in crude oil prices is the downward revision of global demand forecasts. Major institutions like the International Energy Agency (IEA), the U.S. Energy Information Administration (EIA), and OPEC have all reduced their oil consumption projections for 2024 and 2025. This marks a shift from earlier, more optimistic outlooks. Additionally, top Wall Street banks, including Goldman Sachs, Morgan Stanley, and Citi, have also lowered their Brent crude price targets.

This pessimism is backed by weaker-than-expected demand data. In the first half of 2024, global oil consumption growth hit its lowest point since 2020, largely due to slower economic activity and reduced demand from major markets, particularly China. China's crude oil imports in August fell by 7% year-over-year, amplifying concerns over global demand.

While demand weakens, supply-side factors are also weighing on prices. Increased production from non-OPEC countries like Brazil, Canada, and the U.S. has more than offset production cuts by OPEC+. Non-OPEC production has risen by 1.5 million barrels per day (b/d), overshadowing the 1.2 million b/d reduction from OPEC+.

This supply-demand imbalance has resulted in a flattening oil futures curve, reflecting diminished interest in near-term contracts. The shrinking price differential between immediate and future deliveries points to growing fears of oversupply amid weakening demand.

Despite the bearish outlook, there is a chance for a short-term price rebound. Money managers have significantly reduced their long positions in both Brent and West Texas Intermediate (WTI), with net longs reaching record lows. Historically, such low levels of net longs have been followed by price rallies, increasing the likelihood of a brief recovery.

However, BCA Research emphasizes that any potential rally is likely to be short-lived. Analysts noted that even when prices do rise, the average rally lasts only 23 days, which supports the view that any recovery would be temporary.

From a cyclical standpoint, the downward pressure on oil prices is expected to persist. Oil prices typically weaken in the fourth quarter due to reduced demand following the summer driving season. Refineries often undergo maintenance during this period, leading to higher crude inventories and additional downward pressure on prices.

Moreover, the broader economic outlook is not favorable for oil. BCA strategists assign a high probability to an economic downturn within the next 12 months, which could further dampen global demand for crude oil.

Additionally, the recent reduction in Saudi Aramco’s official selling price (OSP) for Asian buyers to its lowest level in nearly three years is another negative indicator for demand prospects.

BCA Research advises investors to reduce their exposure to crude oil, particularly over the next six to nine months. The report highlights the cyclical vulnerability of oil markets and the strong likelihood of continued price declines. While short-term rallies driven by technical factors may occur, these are expected to be brief, with prices likely to resume their downward trajectory once the rallies lose momentum.

The report also casts doubt on the effectiveness of OPEC+ efforts to stabilize the market. Even if OPEC+ continues its production cuts, it may not be enough to prevent an oil surplus by 2025. Deeper cuts would be required, which could lead to internal discord and compliance challenges within the coalition.

Paraphrasing text from "Reuters" all rights reserved by the original author.