Crude oil’s risk premium ebbs and flows

By Ole Hansen, Head of Commodity Strategy at Saxo

Crude oil prices continue to trade nervously with all eyes on the Middle East and what may happen next after Israeli military officials, despite EU and US calls for restraint, said their country had no choice but to respond to Tehran’s weekend strike. The tit-for-tat standoff between these two countries being just one of several developments currently supporting prices. While the Israel-Iran tensions add a non-quantifiable risk premium as supply has yet to be disrupted, energy prices are also being supported by a tight fuel product market driven by Russian refinery disruptions following recent Ukraine drone attacks, a firmer demand outlook for energy amid an improvement in manufacturing data in the US, Europe and China, and not least continued production restraint from OPEC+ producers. 

Overall, developments that have supported year-to-date price increases of more than 20% across the major crude oil and fuel product futures, thereby feeding a continued buildup in long positions held by hedge funds. The crude oil net long in WTI and Brent reached a six-month high last week, not least driven by Brent, the contract most exposed to international developments, which has seen the net long held by money managers reach a 2-1/2-year high above 300 million barrels, a tripling since early December, just before Houthi attacks on ships in the Red Sea helped raise the geopolitical temperature. With fuel products also in demand, the total crude and fuel net long position has reached a two-year high at 728,000 contracts.

With oil demand in 2024 expected to rise by around 1.5 million barrels a day - note the IEA expects 1.2 million barrels per day while OPEC analysts say 2.2 million barrels per day – the prospect for tightening market conditions into the second half will increase the focus on OPEC+ and their June meeting, when the group will decide whether to maintain production restraint, currently around 2 million barrels a day, or slowly begin to add barrels back into the market. 

In the short-term the risk premium will continue to ebb and flow, with focus on Iran’s oil production, currently running at a five-year high around 3.25 million barrels a day after the Biden administration stopped enforcing the sanctions that was put in place during the Trump presidency, and not least the continued safe passage of crude oil through the Strait of Hormuz, the world's most important energy chokepoint. The risk of a disruption remains limited but in a worst-case scenario some of the short fall can be met by another release of oil from US Strategic Petroleum Reserves or key OPEC producers holding a significant amount of spare capacity, deciding to turn up the taps. 

Brent crude oil has settled into a nervous trading range around USD 90, between USD 88.75 and USD 92, with news from Israel and Iran providing most of the intraday volatility. 

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