Oil to range-trade for now. More upside later in the year

Last week, when Brent traded at USD 82.2/bbl we argued in Energy Market Drivers that price risks were neutral. At the time of writing, Brent trades exactly at the same level. This week, it seems that oil has started to trade more on risk appetite and EUR/USD.

Once again, we take a neutral approach to the oil price outlook short-term (the coming week). But risks remain skewed to the upside as the market increasingly will focus on OPEC+ and a possible extension of voluntary production cuts into Q2. We expect an announcement early March. 

We stick to our view from last week that oil prices will continue to rise in the medium term. 

This week, we got the oil market reports from OPEC and IEA. They gave a divergent outlook for fundamentals in the oil market.

Upbeat OPEC report – but who cares? 

The OPEC report maintained a very upbeat view on global oil demand, projected to grow by 2.4 mb/d in 2024. On the supply side, non-OPEC production was pencilled in at 76 mb/d. It leaves a so-called “call on OPEC” of 28.4 mb/d. Considering that OPEC produced 26.3 mb/d in January, it leaves a significant shortfall in the market if OPEC does not lift production this year. One could argue that the voluntary cuts by OPEC+ make no sense if these projections are correct. However, the market is increasingly ignoring the OPEC oil market report. Rightly or not, it is considered non-independent, and few market participants take the upbeat demand forecast by face value.

Downbeat IEA report: Sees an oversupplied market if OPEC does not extend production cuts 

The IEA report, on the other hand, was more downbeat. The IEA says the oil market will soften in the coming months as non-OPEC supply picks up and as oil demand growth is capped by slowing economic growth. The IEA sees an oil demand growth of 1.2 mb/d in 2024, noting that the postpandemic growth phase has largely run its course. The IEA raised its forecast for non-OPEC supply by 0.2 mb/d, forecasting higher oil production in Brazil, Guyana and the US. Notably, the IEA said that the OPEC+ producers would be producing above the requirements (callon OPEC) in Q2 if the production cuts are not rolled over. In that way, the IEA report supported oil prices. It underlined the need for OPEC+ to extend production cuts. Notably, the IEA report has made us more confident that OPEC+ will extend the production cuts in Q2. It leaves an upside for oil in Q2.

Market view gas, power and EUA: About to bottom out 

TTF natural gas continued to drop last week, and the front-month contract is now below EUR 25 Mwh. The TTF spot price is thus rapidly approaching the average for 2012-2021, which was approximately EUR 22 Kwh. If we consider inflation, gas prices are back to pre-war levels.

We published a note on TTF gas prices yesterday. We argue that the price outlook is now starting to look more balanced. Among other things, we see a high probability that the Russian gas imports, which still cover 15% of EU imports, will drop in 2024. We have also started to see nascent signs of an industrial demand recovery.

Importantly, we now argue that consumers should cautiously start to scale into gas hedges that cover winter 24/25 or calendar-25 exposure.

EUA prices have also continued to drop, though we are seeing some indications that prices might be bottoming out.

We have seen improved demand (cover ratio) at the EEX EUA auctions. We have also noticed that speculative accounts have increasingly added to short positions. Hence, the lower prices seem to be increasingly driven by speculators and, to a lesser degree, lack of hedging/physical demand. We often see that the market turns around when many short speculative positions have been added. The market becomes sensitive to positive news (short covering).

One positive news we would highlight from this week is that Germany will “delete” the EUAs that shut down coal power plants will no longer need. Hence, the allowances will not be sold in the market. Remember, one of the reasons why EUAs are under pressure is the more extensive use of renewables, which means less demand for EUAs. However, if these obsolete EUAs are “deleted”, we should expect more future transfers to the Market Stability Reserve (MSR).

The next important event regarding the MSR is the release of the so-called TNAC indicator on June 1st. It tells us how many EUAs are in circulation and how many will be transferred to the MSR from September 2024 to August 2025. We should expect a high TNAC and significant transfers. It will support EUA prices over time.

We hold the same view on power prices as gas prices. We might be close to a cyclical low for forwards.

The market focus will remain on the geopolitical situation in the coming week. However, we doubt we will see a ceasefire next week, and oil prices might continue to see support from a higher risk premium.

Inventory data are back in fashion, and Wednesday’s usual DOE data can potentially move oil markets. This week, we saw a significant jump in US crude oil inventories of 12 million barrels.

Regarding critical economic data, the calendar in the US is relatively thin. In the Eurozone, we will see the release of PMI data for major countries and the Eurozone. We expect a slight improvement, underlining that the European manufacturing sector is slowly improving. On the margin, it could support TTF gas, power and EUAs, though the weather outlook is still the driving factor.

Notably, for the EUA market, the focus remains on the EEX auction and the so-called cover ratio that we see as an indicator for underlining EUA demand. This week, the speculative position data showed that speculative accounts increasingly sold EUAs. It might have exaggerated the move lower.

Table 1 on the next page summarises our market views and hedging recommendations in the different markets.

We maintain our long-held view that Brent prices below USD80 offer an attractive entry level for new consumer hedges for 2024, notably as the global growth outlook has improved. Hence, add to the hedge ratio if we see a setback in Brent below USD80. The risk is growing that Brent has already moved to a higher trading range. 

Hence, even after the recent move higher in various oil products, we still recommend that consumers have a hedging ratio above their individual company benchmark. 

EUA, gas and power: Scale into consumer hedges Power, gas, and EUA prices might fall further in the spring, creating more attractive entry levels for new consumer hedges. However, prices have come off quite a bit, and much positive news is now priced in. It is time cautiously to scale into consumer hedges.

Hence, we now recommend a neutral hedging ratio (at the benchmark) for EUA, gas, and power and no longer a low hedging ratio (below benchmark) for consumer hedging.

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