JPMorgan Chase: Crude oil inventories sharply decline, exacerbating concerns over tight supply

Recently, oil prices have shown a V-shaped trend, with U.S. oil falling from $83.38 per barrel on July 1 to a low of $72.94 per barrel on August 6. As of Monday, oil prices rose again, breaking through the $80 mark to $80.06 per barrel, marking a nearly 10% increase from the low point. However, oil prices fell over 2% on Tuesday.

On Monday, U.S. oil closed above $80, and on Tuesday, it broke through $80 again before falling back to around $78.

The recent rise in oil prices is the result of a combination of factors, including fundamentals, geopolitical conflicts, and speculative activities. On Tuesday, August 13, Morgan Stanley oil trader Tom Skinglsey released some market observations on the crude oil market as of Monday's close.

1) Fundamental Drivers

Skinglsey pointed out that due to expectations of tight supply and declining crude oil inventories, especially with the decrease in inventories at the U.S. Cushing facility, U.S. oil has performed well. The global market has also begun to react to the decrease in crude oil inventories, driving up Brent prices. Arbitrage opportunities in the crude oil market increased by 20 cents, and the price difference between the September and October futures contracts expanded by 30 cents on the day, nearly 90 cents higher than the low point on August 6, making future WTI demand expectations more optimistic.

Cushing is the largest crude oil storage and delivery center in the U.S., and a decrease in inventories there usually supports WTI prices. Despite Cushing's crude oil inventories falling below 30 million barrels, the latest data shows a significant further decline in inventories at the site. Due to the decrease in inventories at Cushing, the market is starting to worry that it may be approaching the operational inventory limit. This means that there is less inventory available for actual operations than usual, which could lead to supply tightness issues. The U.S. domestic market is working to retain crude oil resources, trying to prevent exports or outflows to address potential supply tightness.

Price differentials in other global markets also reflect reactions to the significant inventory reductions in August, with high differentials between the October and November Brent crude futures contracts. Early forward contract prices on Monday also saw good gains, supporting Brent prices.

2) Escalation of Geopolitical Tensions

According to CCTV News, on August 12 local time, John Kirby, spokesperson for the U.S. National Security Council, stated that Iran may launch a "significant" attack on Israel as early as this week. Kirby said that U.S. President Biden had called the leaders of France, Germany, Italy, and the UK on that day to discuss the escalating tensions. Meanwhile, the Israeli Chief of Staff approved plans for operations on different fronts and called on the military to maintain readiness.

Although the situation is tense, there is currently no direct threat to oil supply. However, the market is concerned about potential escalation in the future. Market assessments are evaluating whether the expansion of conflict in the region will affect the crude oil supply of Iran and its neighboring oil-producing countries, leading to tight crude oil inventories and supporting oil prices 3) Speculation Boosts Oil Market Rebound

Skinglsey stated that the current state of the speculative market indicates that despite the recent rebound in the oil market in the past few days, speculators previously held a large number of short positions, and this adjustment in positions may exacerbate the market's upward movement. The buying behavior of systematic investors and signals from trend models also suggest that the market may continue to fluctuate, especially after experiencing strong buying pressure.

Although there has been a rebound in the oil market in the past 3-4 trading days, prior to this, most participants in the speculative market still held short positions. The net managed money (funds managed by fund managers) in the crude oil market remains at its lowest level in the past 5 years, including during the COVID-19 pandemic. The current short positions have reached this year's peak, even surpassing the levels seen during the two major waves of the COVID-19 pandemic. This indicates that speculators hold a significant amount of short positions in the market.

Upon seeing the market rebound, speculators may take buying actions to hedge their previous short positions, leading to a significant covering of short positions in the entire speculative community, resulting in further market uptrend. Trend models have issued a net long signal, especially in WTI crude oil, while Brent crude oil is slightly below this signal. In Monday's trading, we observed systematic investors buying heavily, mainly to cover their previous short positions and potentially start building long positions in the market