Crude Oil Prices May Fall if Ukraine and Gaza Wars Concerns Deflate

Crude oil prices seem to depend on geopolitical fear for support, making them vulnerable to headline risk

• Crude oil prices mounted a steady recovery to retake $80/bbl in June.
• Surging U.S. crude oil output is seemingly at odds with price behavior.
• Anything appearing to deflate geopolitical risk may shock the market.

Crude oil prices inched steadily higher in June. The U.S.-based West Texas Intermediate (WTI) benchmark contract rose 13% from the low above $72 per barrel (bbl) at the start of the month to a high just below $82/bbl. That peak put prices at the strongest level in two months.

A weekly update on inventory flows from the U.S. Energy Information Administration (EIA) is expected to show stockpiles fell for a second consecutive week, shedding 3 million barrels. Downstream, gasoline and distillate stocks are expected to follow suit, losing 1.1 and 1.5 million barrels, respectively. That may help keep prices supported.

Crude oil prices rose despite a sea of supply

Nevertheless, a broader view suggests the U.S. is awash in crude oil. EIA data shows production bottomed out in March 2021 having plunged amid COVID-19 lockdowns. Then it started to rebuild rapidly. By December 2023, the U.S. was producing 13.3 million barrels per day (mbd), the most on record. It was a touch lower at 13.1 mbd in March.

What’s more, production efficiency seems to have improved by leaps and bounds. Baker Hughes reports the number of operational U.S. oil rigs has trended lower since peaking just shy of 1,600 in September 2015. The tally fell to a pandemic low of 183 in August 2020, rebuilt to 627 by December 2022, and has since fallen to 485 this month.

Energy consultancy Primary Vision reveals that the number of crews actively engaged in hydraulic fracturing of shale oil deposits – so-called “fracking”, the innovative extraction method at the heart of surging U.S. output over the past decade – has halved from close to 500 in mid-2018 to just 246 now.

That crude oil prices are tracking upward while output remains so robust seems somewhat counterintuitive. One might have expected that growing production would pressure WTI lower. The lingering presence of a speculative geopolitical risk premium embedded in prices might explain the disconnect.

Oil markets: beware of headline risk

Fighting between Russia and Ukraine continues, with both sides targeting each other’s energy infrastructure. The conflict kicked off when terrorist group Hamas attacked Israel in October is also ongoing. It has fed fears about supply disruptions if a large regional power like Iran is pulled into the fray, and as Yemen’s Houthis strike tankers in the Red Sea.

Interestingly, this has not shown up in the price spread between WTI and Brent, the European crude oil benchmark where the impact of supply disruption stemming from the crises in Ukraine and Israel ought to be outsized. The premium on Brent over WTI has oscillated in a narrow range centered around $5/bbl for years, and that’s where it remains.

This suggests that if it is truly geopolitical risk that accounts for crude oil’s resilience, then it is concern about the increased probability of a supply shock that is at play, rather than actual disruption. This likely makes for outsized sensitivity to news-flow. A stray headline or two deflating risk perception may be enough to give prices a potent downward jolt.

Ilya Spivak, tastylive head of global macro, has 15 years of experience in trading strategy, and he specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak

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