Oil Prices Spiked Again, Will It Last?

WTI crude held above $87 per barrel, hovering at the highest levels over nine months, after Saudi Arabia on Tuesday extended its 1-million-barrels-per-day voluntary oil production cut until the end of the year, according to the state-owned Saudi Press Agency. Russian Deputy Prime Minister Alexander Novak also said on Thursday that Russia agreed with its OPEC partners on the parameters for continued export cuts. Signs that the US economy may be cooling also spurred bets that the Federal Reserve is done hiking rates, lifting overall market sentiment.

Warren Russell, the commodity analyst from BofA Securities, analyzed the reasons behind oil's recent surge and listed further upside risks in his latest report.

■ Demand side: Air travel recovers steadily

Air travel has been steadily recovering from pandemic-related lockdowns globally, with total flights estimated to have reached pre-Covid levels during the peak of summer travel. Strong domestic travel helped to initiate this recovery, while international air travel, particularly to and from Asia, lagged behind. Despite a seasonal slowdown in air travel during the winter holiday season, YoY growth in jet fuel demand is expected to rise at a brisk pace due to steady increases in flight activities out of Asia. Jet fuel demand growth is projected to reach nearly 1 million barrels per day YoY on average in 2023.

■ Supply side: OPEC continues to cut production

Over the past 12 months, OPEC+ production cuts have resulted in reduced supply of middle distillate-rich medium and heavy sour crude oil. Middle East OPEC producers, led by Saudi Arabia, have lowered supply by almost 3 million barrels per day since September 2022.

From the perspective of refined oil, China has tightened its grip on refined product exports in recent years, reducing export quotas for gasoline, diesel, and jet fuel by approximately one-third YoY in 2021. Since then, quota issuance has remained subdued, and so have exports. The country's next batch of export quotas is likely to be received in the next month or two and will determine whether China's exports could rise from YTD average levels during the remainder of the year. It is anticipated that total quotas in 2023 will match 2021-22, which may leave limited upside for China's diesel exports from July levels.

■ Inventories：Low supply offset soft demand, keeping inventories tight

Global petroleum inventories experienced a steady increase from mid-2022 to mid-2023. However, since early August, inventories appear to have peaked and rolled over due to a sharp reduction in OPEC supply. While global petroleum inventories increased, middle distillate inventories struggled to build and have been trending slightly above 2022 seasonal levels in the US, ARA, and Singapore recently. As we head into fall refinery maintenance season, which is expected to be larger than normal, middle distillate inventories are at risk of falling at a faster-than-average pace, leaving the diesel market vulnerable to upside price and crack volatility as winter nears.

■ Risks to note: A potential recession may reverse the above scenario

The economy has outperformed expectations this year, resulting in upward revisions to growth in the US and other countries. Although economists' outlook has become more positive recently, there remains uncertainty surrounding when higher rates will begin to impact activity. If global growth slows down more dramatically than anticipated this fall, it would result in a decrease in demand for all products and could quickly reverse diesel inventory tightness.