Crude Looks Oversold as Balances Tighten

$80 Brent Target for Mid-January

Moderate inventory draws should continue in the coming weeks, as seasonal destocking runs its course. By the end of Q1, relative inventory levels should remain in neutral territory into 2024 and could fall further during the first half of next year. At the same time, with OPEC expected to cut ~990k bpd in output during Q1 of next year, not to mention the expectation that the US output should lose up to 1.5 mbpd throughout 2024, the overall demand-supply balance should continue to tighten. This outlook and a forecast update make the recent selloff in crude and the current extent of contango look overdone. 

First, taking a look at estimated US and global inventories on a relative basis, the sharp but shallow restocking cycle appears to be coming to an end. For the US this has been hastened by strong export demand. The magnitude of this commercial restock is small relative to that which began at the end of 2022, and is matched by very low levels of US strategic reserves. Data suggests that China has also been contributing to seasonal tax selling after a strong year of commercial inventory builds in 2023. For now it does not look like global growth is going to fall out of bed in 2024, implying that crude markets will start the New Year with relatively thin supplies. 

Second, putting this in the context of global supply and demand forecasts for 2024, it is reasonable to expect that there could be a moderate crude supply gap by the middle of the year. Based on the latest such forecasts from the EIA, for example, excess supply could vanish by the end of March, which among other things could support a bullish set up heading into peak seasonal demand months, again supported by OPEC+US output losses. For now this forecast deficit for the second half of 2024 looks mild relative to previous cycles, but it is negative nonetheless. 

Shorter-term, the recent crude sell-off looks overdone, and this isn't helped by the looming holiday dead zone. The latest model run is giving an $80 price target for end January. It is possible that expected successive inventory drawdowns spark a reconsideration of the idea that crude markets remain well supplied, and markets may also come the realization that global growth will not falter in H1 of next year to the extent expected by the loudest voices on the topic. Tentative confirmation from the Fed about rate cut expectations for next year are a tailwind behind this outlook in the present.