Crude prices fall on demand concerns
KUWAIT: Brent futures fell 7 percent in December, reversing gains from a higher geopolitical risk premium earlier in the month due to attacks on vessels in the Red Sea and rising hopes of faster interest rate cuts next year. Demand growth forecasts between OPEC and the IEA remain highly divergent, raising uncertainty around the outlook for 2024.
Oil prices fell into the year-end, continuing a trend of weakening momentum as demand concerns outweighed the impact of renewed geopolitical risks and faster interest rate cuts next year. Brent futures ended December at $77/bbl (-7 percent m/m), closing lower for the third consecutive month and ending the year down 10.3 percent, in sharp contrast to 2022’s gain of 10.4 percent. Kuwait Export Crude (KEC), meanwhile, ended the month at $79.6/bbl (-8.9 percent m/m; -3 percent ytd).
Prices during the month were initially boosted by Houthi rebel attacks on merchant shipping in the Red Sea, causing many cargoes to be diverted to lengthier and costlier routes around Africa, and by hopes that 2024 would see central banks cut interest rates sooner and by more than previously anticipated. The latter followed the release of inflation prints in the US and Europe, which surprised on the downside. Ultimately, however, bearish impulses from easing geopolitical concerns prevailed as shipping resumed through the Red Sea.
Brent futures and options data showed a marked shift in participant positioning, with speculative net length (the difference between the number of bullish “long” and bearish “short” contracts) abruptly reversing course with a sharp, 59 percent w/w increase to 155k contracts (week-ending 19th December). The turnaround was on the back of a drastic pullback in the number of short contracts, which had been the dominant story since mid-October.
The marked deceleration in inflation rates (down to +2 percent y/y in the US and the euro-zone), coupled with fairly resilient US economic data—Q3 GDP expanded by an annualized 4.9 percent—has raised not only hopes of a so-called soft landing but that monetary policy could shift to a more accommodative and thus economically supportive stance in 2024 following nearly two years of rising interest rates.
The International Energy Agency (IEA), citing resilient US economic activity and lower oil prices, revised up its forecast for oil demand next year, pegging growth at 1.1 mb/d (+130 kb/d). This is still less than half of the IEA’s expected growth rate for 2023 of 2.3 mb/d, however, a reflection of macro headwinds including normalization of Chinese oil consumption after a robust rebound in 2023. Nevertheless, consensus on the potential rate of oil demand growth in 2024 has been difficult to establish, with the US Energy Information Administration (EIA) projecting 1.3 mb/d but from a lower forecast baseline and OPEC expecting growth to clock in at a robust 2.2 mb/d, which appears counter-intuitive given the group’s decision in late November to reduce supplies ostensibly to balance weaker demand.
On the supply side, combined data from OPEC secondary sources and S&P Global show aggregate OPEC+ production (quota-bound members) falling to 35.8 mb/d (-153 kb/d) in November. The declines were led by Iraq (-77 kb/d) and Angola (-38 kb/d).Non-quota bound members Iran, Libya and Venezuela, meanwhile, boosted output by a combined51 kb/d in November and by 0.7 mb/d in aggregate in the year to November, a not inconsiderable volume that has had the effect of diluting OPEC+’s supply tightening efforts.
Within OPEC, Angola’s decision to exit the group after 16 years has exposed underlying tensions and laid bare the challenges facing Saudi Arabia as it attempts to rein in global supplies while attempting to maintain cohesion among a bloc of oil producers with widely differing production capacities and capabilities. Angola’s decision to leave OPEC was sparked by disagreement over its potential production capacity, which was assessed by independent energy houses to be far lower than it believed and closer to the level the country was producing at now. Angola was thus unwilling to accept a sharply reduced production quota for 2024, especially one it believed was forced on it in order to make room for a higher UAE quota.
While Angola’s decision to leave the coalition may not have an outsized impact on oil prices given the country’s limited capacity, OPEC’s inability to garner a group-wide consensus to reduce production highlights members’ unwillingness to stomach further output cuts. This could certainly be needed if oil demand growth proves far less robust than envisaged by the group.
Meanwhile in the US, crude oil production rose to a record 13.3 mb/d in December, EIA weekly data showed. US output growth in 2023 topped 1.1 mb/d (+9 percent), a remarkable turnaround from the pandemic and the US oil sector’s best performing year since 2019. It may not be repeated next year, though, if the EIA’s forecasts of a significant slowdown in output growth to just 0.2 mb/d— due to expected declines in the number of active oil rigs and relatively higher cost of credit—bears out.
The outlook for oil prices in 2024 is far from clear.The widely divergent forecasts for oil demand next year underline the uncertainty surrounding oil market fundamentals going into 2024. Easing inflation in the US and EU could allow for a soft landing in the former and perhaps a more aggressive monetary policy loosening in the latter, all potentially boding well for oil demand prospects. Oil supply will remain largely dependent on OPEC policy choices after the first quarter voluntary cuts are set to expire and as non-OPEC supply growth decelerates.
Risks to the demand outlook include a stronger-than-expected consumption growth in India and the Middle East, offset slightly by slower economic activity in OECD economies. On the supply side, OPEC cuts are the main factor for higher prices supported by potentially a stricter US enforcement of sanctions on Iranian crude given recent geopolitical developments, both outweighing the impact of (slowing) US crude production growth. We therefore forecast Brent at $85/bbl in 2024, slightly above $82.6/bbl third party consensus forecasts and up from current prices.