Oil rally: bullish fundamentals versus hawkish Fed
While commodity prices stabilised last year, they have been on the rise again since the beginning of this year. Alongside selected agricultural commodities and metals, oil has also enjoyed a decent rally, with the price rising by almost 20% over the past three months and breaching the $90 per barrel mark for the first time since October (Figure 1). The global oil market has come under intense pressure in recent months, as evidenced by the deepening backwardation of the forward curve. The main reason for this is the decision by the OPEC+ alliance to extend production cuts of2.2 million barrels per day until the end of the second quarter. Meanwhile, Saudi Arabia is voluntarily reducing production by an additional 1m b/d, and Russia by around half a million b/d, on top of the collective cuts. It is the Saudis, the de facto leaders of the OPEC+ cartel, who are cutting the most - their domestic production is only around 9 million barrels per day, more than 3 million barrels below maximum production capacity.
Iran's recent attack on Israel was yet another reminder of how tense the current geopolitical situation is. The Iran-Israel conflict saw the first ever direct attack by Iran on Israel, which the Jewish state was able to repel with the support of its allies. The immediate market reaction was surprisingly muted, both in terms of oil prices and, for example, US government bonds, which are typically a safe haven in times of geopolitical tension. In other words, markets believe that further escalation into a wider regional conflict is not imminent. Nevertheless volatile geopolitics have also contributed to the rise in prices in the first quarter. In particular, the recent Ukrainian attacks on Russian refineries and the disruption of tanker traffic in the Red Sea. This has had a particular impact on the heightened tensions in the Middle East middle distillate markets. The spill-over of higher refinery prices for diesel to Europe is not a serious risk, as the heating season has ended.
The OPEC+ production restrictions alone should keep the market in deficit in the second quarter, given that oil demand remains solid. Prices should therefore remain solidly supported by the bullish fundamentals in the coming months. These could help oil make further gains towards $100, but for more significant gains, additional impetus would be needed. There could be supply-side disruptions in the context of a tense geopolitical situation, but these are inherently difficult to predict. The outlook for the second half of this year is also in the hands of OPEC+. At least a partial extension of the production cuts is likely (depending on the oil price), without which the oil market would return to surplus. Fed policy will also play an important role in price developments. Indeed, if the expected monetary easing does not materialise, or falls well short of market expectations, this would be bad news for risk assets. And that includes oil, which - in the absence of additional supply shocks - would find it hard to stay in the $90-100 per barrel range.