Crude Down Again on China Concerns, But Analysts Think Market Fears May Be Unfounded

Some experts think we may even be heading into a tight crude market: File Image/PixaBay

Following Thursday's rally in which crude prices rose to their highest since late September, Friday's trading session saw crude once again fall as concerns mount that China and the U.S. won't be able to make their long-promised trade deal.

Once more, the fears were based on the flimsiest of circumstances, this time on news Friday that Chinese president Xi Jinping said his country wants to work out an initial trade pact with the U.S. and has been trying to avoid a trade war - but is not afraid to retaliate when necessary.

China has also invited top American negotiators for a new round of face-to-face talks, but traders took little solace in this and on Friday caused Brent to decline by 58 cents to settle at $63.39 per barrel; West Texas Intermediate fell 81 cents to settle at $57.77 per barrel.

But the declines didn't surprise analysts: Michael McCarthy, chief market strategist at CMC Markets and Stockbroking, said, "The key factor for the demand outlook for oil is the trade negotiation, [and] with oil near the top of recent trading ranges, it's no surprise to see a bit of selling pressure."

The irony of trading behaviour of late is that while media headlines - and analytical forecasts - have focused on fears of a perceived crude glut globally due to low demand, the physical market appears to be radically different.

This was emphasized by a Reuters report disclosing that while traders are prepared to pay near-record premiums for sweeter barrels to align with new marine fuel regulations, "premiums for heavier grades, which produce more fuel oil, also continue to rally due to a deficit created by U.S. sanctions on Iran and Venezuela."

The report went on to note that "In addition, the structure of the oil futures market shows that premiums of front months to later dates – known as backwardation – have narrowed in recent weeks, also suggesting the market's expectations of a glut are diminishing somewhat."

Reuters concluded that the physical crude oil market and the structure of the oil futures curve have rarely been more aligned over the past few years than in recent weeks, "and they tell a counterintuitive story of a tight oil market next year."

Also bucking the trend of glut forecasting was John Kemp, commodities analyst for Reuters, who on Friday stated that "Crude oil traders are betting the market will tighten significantly next year, even as the major statistical agencies predict production will outstrip consumption and oil inventories will rise."

Kemp too cited the backwardation of Brent, noting that it "is not associated with any sudden loss of oil supplies; instead, it reflects the combination of steadily tightening supplies and expectations for faster demand growth in 2020."

Kemp added that "Recent financial market and industrial data suggests the current cyclical downswing in the global economy may have past its worst point," and that if that proves correct, "there is potential for a cyclical upswing in 2020/21, similar to the recovery in 1999/2000, after a similar mid-cycle slowdown in 1997/98."