Oil Market Drops on Fears of Demand Destruction

We expect more pain in this sector at least in the short to medium term.    Saudi Arabia along with Russia as part of Opec+ had agreed to keep the production cuts and a weaking outlook may have played a role in this decision.  The EIA’s latest inventory report showed a gasoline inventories rising by 6.5 million barrels. Thus, increasing inventories combined with weaker demand for gasoline do not bode well for oil prices hitting market sentiment.

With recently approaching $100, the oil producers faced demand destruction risk.  Demand destruction occurs when a period of high prices or restricted supply causes consumers to permanently change their behavior. This results in a reduction of demand for a good even after the supply of the good goes up and/or its price goes down. Demand destruction is often associated with the demand for oil or other energy commodities.  Thus, there was always a limit to how high oil could go and if you factor in a strong dollar the costs to consumers and business was high worldwide.  This meant that Saudi Arabia and Opec+ had to tread carefully.

As mentioned in our last post on the oil market, we did not see oil going to $100 and took a contrarian view that oil prices would drop based on several risk factors in the market.  The looming economic slowdown, a market on the edge, rising long-term bond yields, uncertainty regarding monetary policy – see the ‘higher for longer’ talk for the federal reserve and geopolitical concerns.  I forgot to mention the turmoil in the US government, etc.

We maintain our short to medium bearish view on the price of oil and oil stocks in the context of deteriorating economic growth and market conditions.   In addition, October is historically the month that typically has the lowest oil price due to seasonal factors in the oil market.  Our view is also in line with recent comments by Ed Morse from Citibank (on Bloomberg Video) who sees oil going to $70 a barrell in the medium term.  He also mentions that non-Opec production is increasing thanks to the recent high price.  Today, Natasha Kaneva head of the global commodities team at JP Morgan further supported the lower oil price view.

We are maintaining our negative position, on oil stocks.  Below you can find the price charts for BP and Exxon (XOM).   The oil stocks tried to recover early on in the trading day, but you will see that sentiment is starting to reverse and we could be looking at three days of losses for oil stocks.  Disclosure: our market call on oil was correct and positions have gained between 30 to 50%.

BP Stock Price as of Midday 5th of October 2023

XOM Stock Price as of Midday 5th of October 2023