Oil Hits 7-Year High. Should We Brace for a Steep Decline？

Oil serves as an investment vehicle and an input cost for almost every commercial good.

The global economy has managed to shake off the pandemic shackles, resulting in growing demand for crude oil markets. Demand growth averaged 5.5 million barrels per day (bpd) in 2021, pushing WTI to become the best performing non-crypto asset class. Crude continued to rally as we entered the new year, hitting a 7-year high in January. While some investors braced for a sharp downturn, oil exhibited great resilience. Crude breached the important $90 per barrel resistance level, only to climb past $92 by February 4.

The record run had very few detractors. Money managers had a long position volume of almost 340,000 in WTI crude, eclipsing their short positions of around 27,000, in January. Market volatility threatened to spike early in the year but quickly returned to medium-term averages. Oil serves both as an investment vehicle and an input cost for almost every commercial good, and its price is critical to a wide range of investments. So, how concerned should investors be about market exuberance and a potential correction ahead？

Well Take It Lock, Stock, and Barrel

The global economy needs oil to keep its wheels greased. In its January 2022 meeting, the OPEC+ raised its demand forecast by 260,000 bpd, citing stronger demand from the advanced economies despite the spread of the Omicron variant. In the US, for example, November 2021 saw traffic reaching the highest in a decade, 12% more than in November 2020, when there were restrictions to curb the Delta variant. Although Omicron cases rose, restrictions were significantly less harsh, dampening the virus's impact on oil demand. Developing nations also exhibited demand resilience, with rising traffic and factory activity in Asia.

Demand for crude as a substitute for natural gas has also recently grown. Natural gas contract prices have not only surged but also remained incredibly volatile. The IEA estimated this trend towards crude as a substitute to have created the demand for 100,000 bpd in December. This is also reflected in the largely positive sentiment for oil and the overly negative one for natural gas on Acuitys Trading Dashboard.

Additionally, the demand strength is evident in the markets forward curve. Brent crude backwardation, the difference between front-month contract and 6-month due contract, has climbed to its steepest since 2013.

The IEA also revised its total demand forecast for 2022 to a whopping 99.7 million bpd, which is 200,000 bpd higher than the pre-pandemic levels in 2019. The OPEC's Joint Technical Committee (JTC) is more optimistic, predicting oil demand to grow by 4.2 million bpd this year.