The Surprising Drop In Inventories In The US Fails

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Oil futures were experiencing a day of respite after several sessions dominated by volatility. However, this year it seems that it will not be calm for crude oil. Oil futures have started to move higher in mid-afternoon, after the US Department of Energy published an unexpected drop in crude oil and gasoline inventories.

However, despite the drastic drop in commercial reserves, crude oil has once again made another ‘pirouette’ to trade once again in the red and approach 90 dollars per barrel. Oil futures have been experiencing several days tinged with red (corrections) due to low demand in China and the possible return to the global market of Iran, both factors threaten to create an excess supply that would put downward pressure on the price of crude oil.

Not even the data on inventories has been able to suffocate the bleeding of oil. As published by the Department of Energy, oil inventories in the US have been reduced in the week by 7.1 million barrels , the largest drop since April, when oil was trading above 120 dollars a barrel. On the other hand, gasoline inventories have fallen by 4.6 million barrels, when a reduction of just over one million barrels was expected.

Oil thus moves away from 100 dollars . After flirting with the $90 zone this morning, the drop in inventories seemed to have given some life to crude, which came close to the $95 per barrel zone. But volatility is once again the star of the day in crude oil.

Before the data on inventories, oil had already been suffering several sessions of relevant losses, which have led Brent to lose 16% in the last fifteen days of trading. This is the framework in which crude oil moves. The sharp drop in reserves this Wednesday is a boost for crude oil, but in principle it should not end the pessimism that was prevailing in this market.

China and Iran move the market
The shadow of China and Iran are elongated. Both countries, one for demand and the other for supply, have the potential to drag crude oil in the coming weeks. The economy of the ‘Asian giant’ is failing to recover after the confinements at the beginning of the year. At least it is not doing it at the speed that the market expected.

If China does not resume year-on-year growth above 5%, the consumption of oil derivatives could be structurally damaged. Furthermore, in the short term, the housing crisis is getting worse by the minute , while consumer confidence has plummeted. For this reason, the country’s oil consumption is showing great signs of weakness and, in this way, weighing down the world demand for oil, according to experts.

Warrent Patterson, commodity expert at ING, said: “Chinese data is coming in weaker than expected and has raised demand concerns once again, not just for oil, but for the broader commodity complex. Additionally, refining activity in July fell to its lowest levels since March 2020, while apparent demand fell by around 10% year-on-year. These demand concerns have coincided with a recovery in the dollar.”

Chinese refineries do not start
China’s refineries are demanding much less oil than in the past to convert it into derivatives (gasoline, diesel, kerosene…): “China’s oil derivatives production fell to a 28-month low of 12.58 million barrels per day in July, which represents a surprising 6.3% month-on-month decline compared to the increase expected by refining analysts,” S&P Platts said.

S&P Global data reveals a drop in the use of the country’s large refineries. “The country’s four state-owned refineries reduced utilization rates to around 73.5% in July from 75% in June. Hengli Petrochemical Refinery (Dalian) reduced its utilization rate by eight percentage points month-on-month as of 74% in July, while the Zhejiang Petroleum and Chemical refinery reduced it by two percentage points over the same period to 82%.

Commerzbank experts believe that in addition “problems in the real estate sector, in addition to the government’s zero-Covid strategy, are likely to continue to weigh on the economy in the short to medium term, which means that oil prices will probably face Persistent headwinds on this side.

Still, there is some mystery. The production of oil derivatives in China is still too low, even taking into account the problems that the economy is going through: “There is no reason to reduce refining by 6% in the second quarter, although the recovery is slower than expected.” that we expected in early July,” a Beijing-based analyst told S&P Platts who had estimated a monthly increase in crude oil production for July.

What if Iran returns to the market?
On the other hand, there is the option of Iranian oil returning to the market. This is an additional factor weighing on prices after the negotiation process between Iran, the EU and the US on a new nuclear deal continued. This week, the Iranian government sent its response to the EU’s draft proposal, expressing general optimism that a deal could be achieved as long as the US is willing to compromise on unresolved issues. However, even if a new deal were signed, it would presumably be some time before the sanctions could be fully lifted.

For example, when the 2015 agreement was reached, it took about half a year for Iran to start exporting its crude oil in quantities similar to those before the sanctions. It is estimated that Iranian crude production could increase by 500,000-700,000 barrels per day.

This option that has been talked about for a long time is starting to win integers. The Biden administration is weighing Iran’s response to the European Union’s proposal to revive the deal. Although it is true that the White House has refused to comment in detail on the European Union’s proposal officially, State Department spokesman Ned Price said Tuesday that the big problems have been “largely resolved.”

If China’s weakness persists and Iran ends up returning to the markets, oil could face a somewhat turbulent future. These two forces would push the price of crude oil down significantly, while the war in Ukraine (especially the sanctions against Russia) and the lack of investment in the sector would continue to be factors that should push the price of crude oil up. Given all this uncertainty, only one thing seems to be clear: volatility will remain very high.

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