‘Overbought’ oil down 2%’; more downside likely if bond selloff continues

© Reuters.

Investing.com - “When push comes to shove” — the phrase seems to be making itself evident with the oil market, where the sharpest correction in nearly two months occurred on Thursday on overbought crude futures that have risen more than 30% since the end of May.

The so-called profit-taking pulled New York-traded West Texas Intermediate and London’s Brent from latest highs above $95 per barrel that marked a near 13-month peak for U.S. crude and a 10-month high for the U.K. benchmark.

Analysts said the possibility of the correction continuing was as high as the oil rally restarting.

“Unless a major de-risking moment occurs, the oil market will still remain tight throughout the rest of the year,” Ed Moya, analyst at online trading platform OANDA, said.

Still, he acknowledged that “oil was ripe for a pullback”, after coming a few dollars short of the $100 level, and risk of downside was open if the worldwide selloff in bonds — a precursor to recession — continues. 

“Energy traders are quickly locking in profits given the turbulence happening in the bond market.  Crude demand destruction will clearly happen globally if this bond market selloff extends,” added Moya.

Moya put major support for Brent at  $87.75 and WTI at $84. That would mean a downside of another $5 to $7 in both the benchmarks if de-risking extends.

WTI for delivery in November settled at $91.71 per barrel, down $1.97, or 2.1%, on the day. It earlier reached $95.04, its highest since August 2022. On Wednesday alone the U.S, crude benchmark jumped 3.7%.

London-traded Brent for December delivery settled at $93.10 a barrel. That was down $1.26, or 1.3%, on the day. On Wednesday, it rose 2.1%. 

OPEC+ production squeezes ... helped by U.S. producers

Oil prices have gained between $25 and $30 from May lows of beneath $64 for WTI and $72 for Brent. The rally was largely in response to production squeezes by Saudi Arabia and Russia in their bid to “balance” the market — or rather create an imbalance so great between short supplies and stagnant demand that prices would have no choice but to rise.

The two prime movers of the OPEC+ alliance — which bands the 13-member Saudi-led Organization of the Petroleum Exporting Countries with 10 independent oil producers steered by Russia — have also benefited from a tacit collusion by U.S. oil producers.  

While antitrust laws forbid U.S. energy companies from participating in OPEC-like schemes that are against the spirit of free-market competition, American oil majors, lured by the Saudi bent in getting a barrel back to above $100, have restrained production too whenever possible in the name of returning cash to shareholders. 

Demand for U.S. crude has, however, exploded internationally as it began to fill some international markets underserved by the Saudi-Russian squeeze. That has led to a plunge in inventory levels at the Cushing, Oklahoma hub that serves as a central delivery and storage point for U.S. crude. This is especially so with the pick up in shipments of a new U.S. crude grade called WTI Midland — which is comparable to the viscosity of the heavier Arab and Russian oils versus the typically light-grade that’s WTI.

OANDA’s Moya isn’t the only one who thinks the oil rally will have to cool with the global economy.

Long oil: An overcrowded trade

Reuters' market analyst John Kemp says oil traders have placed so many bullish bets on crude prices that the trade has become overcrowded and was due for a correction.

In his latest column on oil buying among institutional traders, Kemp pointed out that over the past four weeks, traders had bought a total of 183 million barrels of crude and fuel futures. That has brought the total up to 525 million barrels. More importantly, the ratio of bullish to bearish bets on oil and fuels had risen to almost 8:1.

According to Kemp, this is a sign that oil prices may start reversing their gains before too long. 

Others, however, anticipate even higher prices, with JP Morgan saying this week that Brent could reach $150 per barrel. Other commodity analysts see Brent hitting $100 before this year's end. 

Wall Street: Watch that bond market selloff more than oil

But Wall Street’s forecasters are often too caught up in chasing a market one way that they ignore counteracting forces. And one of the bigger risks to the oil rally remains the Federal Reserve and its higher-for-long regime for U.S. interest rates.

Fed Chair Powell told a news conference last week that energy-driven inflation was one of the central bank’s bigger concerns.

The Fed has raised interest rates 11 times between March 2022 and July 2023, adding a total of 5.25 percentage points to a prior base rate of just 0.25%.  It could add another quarter point in November or December and more likely in 2024.

U.S. Treasury yields, benchmarked to the U.S. 10-year note, shot to fresh 16-year highs on Thursday, on expectations over Fed hikes. That bond market selloff could do the oil rally in ultimately, say analysts.

(Ambar Warrick contributed to this item)