Oil price rebound momentum could persist but don’t expect major gains

Oil prices have bounced back from their early September slump, with Brent crude recovering nearly 9% from its recent lows. While the initial sell-off seemed overdone, the medium-term outlook remains cautious as oversupply continues to weigh on the market in the coming months. The current rebound still has some momentum, but Brent is unlikely to break back above the $80/bbl mark anytime soon.

Extremely bearish financial positioning supports recent gains

A key driver of this week’s price recovery is financial positioning in the paper market. As noted earlier, bearish sentiment in oil positioning had reached levels not seen even during the peak of the COVID-19 crisis. For the first time ever, money managers’ net positioning in ICE Brent turned negative. This extreme positioning has fuelled the recent rally, leading to short squeezes. Additionally, macroeconomic factors such as the Fed's 50 bps rate cut have helped lift oil prices, as the dollar index hit its lowest level since mid-2023.

Physical market signals resilience

Despite the drop in flat prices, the physical oil market remains relatively robust. Time spreads for key benchmarks like Brent, WTI, and Dubai continue to show backwardation, with WTI and Dubai's three-month spreads hovering around $2/bbl and ICE Brent around $1.20/bbl. While these curves have flattened somewhat, indicating weaker demand, there’s no clear sign of a significant oversupply, suggesting that the recent front-month price drop may have been exaggerated.

Libyan supply disruptions are expected to persist, curtailing some 600 kbd of light sweet supply, while Hurricane Francine has reduced Gulf of Mexico output by about 120 kbd on a monthly average basis. Meanwhile, lower oil prices are creating buying opportunities for Chinese refiners like Unipec, Sinochem, and the new Yulong refinery, which reportedly purchased eight cargoes of Upper Zakum crude from ADNOC. Additionally, lower OSPs from Middle Eastern producers are driving increased demand, with Chinese and Indian refiners raising their October nominations for Saudi grades.

Crude differentials for Russian ESPO, Iranian Heavy, and Venezuelan Merey grades have also strengthened due to renewed interest from Shandong independent refiners seeking discounted barrels. However, this may be short-lived as ESPO shipments have declined from 940 kbd in July to an average of 825 kbd in August and September. US waivers for Indian refiners to buy Venezuelan crude have led to the resumption of Merey shipments to India, which reached 108 kbd in August, the first such flows since May, further boosting differentials in Eastern Asia.

Venezuela crude exports by destination country, kbd

Source: Kpler

Geopolitical risks rise

Geopolitical tensions in the Middle East also add to the bullish factors in the short term. The recent explosion of thousands of missiles in Lebanon, potentially involving Israel, raises the risk of further escalation. While the market typically brushes off provocations – for good reasons – a direct confrontation remains a risk. The killing of Ismail Haniyeh in Iran has yet to provoke a direct response, but we believe that the IRGC and Supreme Leader Khamenei will push for a retaliatory targeted strike in the coming months, a risk that is not yet priced in.

Although neither Iran nor Israel seems keen on a full-scale war, Iran encourages its proxies to engage in prolonged military actions to keep Israel on the defensive. As a result, Houthi attacks in the Red Sea and around the Bab el Mandeb will continue to affect tanker rates.

Suezmax rates from the Mideast Gulf to NWE, $/bbl

Source: Baltic Exchange, Kpler

OPEC+ will stick to its strategy

OPEC+ is in a tricky position, as any decision to adjust production could be interpreted negatively by the market. However, we believe the group will remain focused on price stability rather than pursuing a market share strategy. The decision to delay production hikes was prudent. With non-OPEC+ production, including Brazil, expected to increase by nearly 900 kbd in 2025, there’s little room for OPEC+ to add significantly more barrels to the market next year, something that isn’t accounted for as the market still expects the group to start hiking output from December onwards.

Non-OPEC vs OPEC+ y/y supply growth, kbd

Source: Kpler

Refining overcapacity will prevent prices from rising much

Despite some bullish indicators, fundamentals are likely to worsen in the coming months. Overcapacity will continue to pressure refining margins, especially with the ramp-up of new refineries like Dangote, Yulong, and Dos Bocas. This will likely lead to run cuts across the board. We project crude and condensate balances to show an average surplus of 539 kbd in Q4 2024 and Q1 2025, which will ultimately limit any significant price increases.

In conclusion, Brent's upward momentum could continue for a few more sessions as the market's earlier pessimism gives way to some bullish factors. However, fundamentals are likely to reassert themselves, especially if Brent approaches the $80/bbl mark.

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