Commodities Week Ahead: Oil Bulls Bet on China Reopen; Inflation the Wild Card

• China reopens international borders, removing last of draconian COVID policies
• Oil bulls bet on China story, but Fed, inflation remain wild cards in crude rally
• Fed's Powell to speak Tuesday, CPI reading due Thursday 

Oil bulls might finally be able to count on a positive China story this week as the No. 2 economy reopens its international borders to eliminate the last vestiges of the draconian COVID rules that shaped much of Beijing's policy over the past three years. 

Yet, this week's rebound in oil could be limited by speculation over what Federal Reserve Chair Jerome Powell might say about interest rates in his speech at a central bank conference in Stockholm on Tuesday, ahead of Thursday's more important Consumer Price Index reading for December. 

New York-traded West Texas Intermediate, or WTI, crude was at $74.40 per barrel by 00:30 ET (05:30 GMT), up 93 cents, or 1.3%, as trading for the U.S. oil benchmark entered its second week of the year in Asia.

 The global oil benchmark, London-traded Brent crude, was at $79.48 per barrel, up 91 cents, or 1.2%. 

Those long crude are eager to see some upside in both the benchmarks after their tumble of more than 8% last week that resulted in oil's worst weekly loss in a month. The first two trading days of 2023 itself saw a 10% loss for WTI and Brent — their biggest plunge for the start of any trading year since 1991. 

Prices of crude to refined products and natural gas have all plummeted since this year began due to unseasonably warm winter weather and signs that the Ukraine conflict and sanctions on Russian oil exports had led to overblown fears of a supply squeeze. 

China and India are buying heavily discounted Russian oil and refining it for resale to the world. European gas stocks are well above seasonal norms. Saudi Arabia, the biggest oil exporter, has slashed prices on its own crude to Asia to compete with Russian oil, which is getting cheaper by the day. The OPEC+ oil producers' alliance run by the Saudis, with coordination from Russia, actually shipped more oil in December after promising to cut output. 

Gary Ross, a veteran oil consultant turned hedge fund manager at Black Gold Investors, said in comments carried by Bloomberg:

"To me, the market is oversupplied by at least 1 million barrels a day. We are going to have large stock builds. In a couple of weeks, you're going to be building 10 million barrels a week; how is the market going to handle that?" 

Even Goldman Sachs, a cheerleader for oil for most of last year, says it is too early to tell whether prices will quickly recover this time.  

The oil curve may strengthen as demand recovers, and as the market works through spare OPEC capacity, analysts at Goldman Sachs said.

The Wall Street bank predicted Brent would average $90 per barrel in 2023, down from $110 earlier. This week, it forecasted U.S. natural gas prices would drop to $4.00-$4.20 per mmBtu, or million British thermal units, in the second quarter through the third quarter, after trading as high as $10 per mmBtu in August. 

Thus, some are hoping the China story will provide the oil market with the enthusiasm it needs.

"Oil prices have been positively correlated with inflation since 2022, though China's reopening may buffer the decline in the near term," said Tina Teng, an analyst at CMC Markets, in a note published by Reuters. 

Demand for oil in China typically rises each year after the Lunar New Year, which, this year, is due at the end of January. But with Beijing going from a zero-COVID to a que-sera-sera COVID policy, there's no telling now how its oil demand will fare. Data for the just-ended week showed Chinese manufacturing activity shrank for a fifth straight month in December, as the country grappled with an unprecedented spike in Coronavirus cases.  

Domestically, some 2 billion trips are expected during the Lunar New Year season, nearly double last year's movement and recovering to 70% of 2019 levels, Beijing says. However, concerns remain that the massive flow of travelers may cause another surge in infections and cap recovery in China's economic activity.

China has kicked off the year by buying large quantities of oil despite its worrying COVID situation. But the Chinese actions seemed geared more towards storing crude than buying it for immediate use. In the energy universe, rising storage often tends to depress prices. 

China has also increased export quotas for refined oil products in the first batch for 2023, signaling expectations of poor domestic demand. Its focus is on the international market as independent refiners in the country see higher profits from processing Russian oil, made cheaper by the day by western sanctions on Moscow that gives the Chinese leverage to negotiate for steeper discounts. 

If China's economy performs slower than expected, then the large quantities of oil it is buying now will likely end up in storage. Such an expansion in storage could widen the contango in oil. Both WTI and Brent are now in contango, a market dynamic where longer-dated oil is priced higher than nearby contracts, making it unprofitable for those trying to hold a futures position by rolling out of the expiring front-month into the next closest contract. 

At Friday's close, the contango between the February and March contracts in U.S. crude was at 27 cents a barrel. The difference between March and April Brent was 18 cents. By historical standards, the price gaps are small. But they could grow if the storage situation expands. 

China is ramping up its output of refined oil products for export to make up for its tepid oil demand at home. The result would be more competition to other international suppliers of refined products, including the United States, and more pricing pressure on this front. 

In past years, the Chinese were major suppliers of refined products to the Pacific markets. But they slashed their refined production abruptly last year as domestic demand for oil fell — a decision that the powers-that-be in Beijing are presumably lamenting.

"The Chinese totally missed out on last year's huge crack spreads for refined products by limiting the capacity of their independent refiners," said John Kilduff, partner at New York energy hedge fund Again Capital. 

"The Chinese thought they were protecting their internal oil market with the curtailment in production, without realizing the damage they were causing to their export market for refined products. They have woken up to that now." 

U.S. inflation figures and the start of corporate earnings season will be the main highlights of an otherwise quiet week on the economic calendar. Inflation data for December will help influence the size of the Fed's next rate hike, while corporate earnings will give an important insight into the health of the economy amid concerns over a potential slowdown.  

Fed officials on Friday acknowledged cooling wage growth and other signs of a gradually slowing economy, with Atlanta President Raphael Bostic hinting at the chance of a quarter percentage point hike at the Fed's next policy meeting on Jan. 31 – Feb. 1. It raised rates by 50 basis points in December.

The CPI reading for December is expected to show that core inflation increased 5.7% from a year earlier. Any sign that price pressures are continuing to ease could not only reinforce the view that the Fed is nearing the end of its most aggressive tightening cycle in decades but may also fuel speculation that rate cuts could come later this year. 

Disclaimer: Barani Krishnan uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables. He does not hold positions in the commodities and securities he writes about.