Why Did Oil Prices Rise In Reaction To SPR Release And What Does It All Mean For Oil Prices Looking Ahead?

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Why Did Oil Prices Rise In Reaction To SPR Release And What Does It All Mean For Oil Prices Looking Ahead?
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Crude oil prices remained higher on the week at the time of writing on Thursday, as we enter a potentially quieter period for the markets, with many US investors taking a day or two off for Thanksgiving. This week’s rebound in oil prices come following four weeks of declines from the fresh multi-year highs that were hit at the end of October. Prices were flat on Wednesday after a sharp rally the day before, when the coordinated release of strategic stocks by the US and a few other consumer nations failed to have the intended influence on prices. While wondering what – if any – impact the coordinated release might have on prices in the slightly longer-term outlook, oil investors will be looking forward to next week’s meeting of the OPEC+ group and keeping a close eye on the Covid situation in Europe as the threat of fresh lockdowns threatens demand for oil.

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Why Did Oil Prices Rise In Reaction To SPR Release And What Does It All Mean For Oil Prices Looking Ahead?

It should be noted that prices had already dropped about 10% over the past few weeks ahead of the coordinated release of strategic oil reserves by the US, China, Japan, South Korea and the UK. Thus, the actual announcement was never going to have a significant impact anyway. It was simply a case of “buy the rumour, sell the news” – or in this case, sell the rumour, buy the news.

What’s more, the actual SPR release by the US is not effectively 50 million barrels, as 18 million will come merely from ramping up an already planned release, which has so far supplied around 31 million barrels into the market in 2021. The rest of the SPR release, totalling around 32 million barrels, is not too much to impact prices significantly, while international contributions are also insignificant. In any case, reserves will eventually have to be refilled at some point anyway.

So understandably, traders have not been in any rush to sell much oil in reaction to the news.

Can SPR Release Still Offer Some Resistance To Oil Prices?

The SPR release will add more oil to the market in the short-term, which coupled with the gradual ramping up of OPEC production should relieve some pressure on prices. By the time the US and others think about re-filling their SPRs, the OPEC+ will have probably hiked production back to pre-Covid levels.

Thus, while clearly adjusting SPR levels is a zero-sum game in the long-term, it does impact the total supply of oil in the short-term, which should, in turn, impact prices. As mentioned, the recent drop in oil prices may have been a reflection of investor expectations about this. And we may see some delayed reaction in the weeks ahead.

How Will OPEC+ Respond?

Oil investors will now shift their focus on the OPEC+ meeting scheduled for December 2. The group has already threatened to reduce future production hikes in response to the coordinated SPR release. However, we don’t think they will retaliate. For one, starting another oil war is not in their interest at all. For another, the OPEC+ needs the support of consumer nations like India and Japan. Consequently, we reckon the OPEC+ alliance will continue to ramp up production at the rate of 400K barrels per day in December. If that’s the case, we may see a spike lower in oil prices as investors price out any risks of retaliation that they may have previously expected as a result of the SPR release.

What Other Factors Might Negatively Impact Oil Prices?

In short:

  • threats of new lockdowns in Europe (bearish)
  • emerging market currency crisis could hurt demand e.g. Turkey (bearish)
  • implied US oil consumption at lowest since June as stockpiles and production recover (bearish)

With surging cases of Covid in Europe, there is a real threat of fresh lockdowns being introduced in the weeks ahead. If so, and all else being equal, this should mean lower demand for oil as travel is restricted.

Meanwhile, the ongoing currency crises for Turkey and a few other emerging markets is getting worse day by day. The Turkish lira has lost more than 60% of its value against the dollar year-to-date. This means buying oil costs around 60% more compared to last December, just because of the adverse exchange rate movements. Turkey is not alone. year-to-date, Pakistani rupee is about 9% lower, South Korean won is slightly more and Japanese yen about 11% worse off compared to the dollar. For as long these oil consumer nations face weakening exchange rates, or in the case of Turkey, a currency crisis, demand for fuel, holidays abroad (meaning less travel) and foreign imports (which could weigh on growth elsewhere) all point to lower oil demand. Meanwhile, inflation is rife across the world, meaning people will be even less willing to spend what little of their disposable incomes are left on luxury goods and services such tourism.

Additionally, recent crude stockpile reports from the US point to recovering oil inventory levels, as well as production. Stocks of crude at the Cushing hub now sit at a four-week high, meaning the market is not as tight as it was a couple of months ago. Indeed, total crude products supplied, which is a measure of oil consumption, has been falling. Its 4-week average is now at the lowest volume since June.

What Does It All Mean For Oil Prices Looking Ahead?

We think that the risks are skewed to the downside from here, while accepting that it is possible that we may see some short-term strength in oil prices. But the next $10 move is highly likely to be to the downside than upside from here, for the reasons stated above.

While every effort has been made to verify the accuracy of this information, EXT Ltd. (hereafter known as “EXANTE”) cannot accept any responsibility or liability for reliance by any person on this publication or any of the information, opinions, or conclusions contained in this publication. The findings and views expressed in this publication do not necessarily reflect the views of EXANTE. Any action taken upon the information contained in this publication is strictly at your own risk. EXANTE will not be liable for any loss or damage in connection with this publication.

Article By Victor Argonov, senior analyst at WealthTech EXANTE

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