Did the stabilization of the banking system, China National Petroleum Corporation's positive forecasts of a 6.2% increase in Chinese crude imports in 2023 to 540 million tonnes, and the halt of exports by 400k bpd from Ceyhan port due to the legal dispute between Iraq, its semi-autonomous Kurdistan region and Turkey, really become a catalyst for the Brent rally? Or, according to Trafigura Group, do some of the movements in the market actually have nothing to do with oil? They say that the recent collapse is the closure of positions previously opened by producers as part of delta hedging operations of the risks of falling prices.

The oil market in 2023 is a massive disappointment. It is not fashionable to keep this asset in portfolios nowadays. If at the beginning of the year, hopes for rapid demand from China due to the end of its zero-COVID policy, the weakness of American producers, and the belief in a reduction in supplies from Russia due to Western sanctions imposed on it allowed banks and investment companies to predict the growth of Brent to $100 per barrel, now it becomes clear that this is utopia.

The market has been in the grip of the bears for a long time: over the past two weeks, speculators have built up net shorts on the Texas grades to their highest levels in more than a decade, while bets on a downturn in the U.S. economy are at a four-year high. Oil reversal risks in the form of the ratio of premiums on call and put options have dropped to the lowest level since the end of 2021, indicating a bearish market situation.

Dynamics of oil reversal risks

In reality, however, this environment is optimal for starting a rally. When there is too much negativity in the market, downward trends break. Indeed, if speculators were to start winding down short positions while producers start buying derivatives as part of a delta hedge of downside risks, everything would immediately turn upside down. Trafigura Group is probably right: the recent collapse was the result of massive sales of futures contracts, the volume of transactions with which intermediaries jumped to the highest levels since 2018.

Dynamics of swap dealers' positions in the oil market

In my opinion, the future fate of oil will depend on the situation in the U.S. economy. Will it plunge into recession due to the banking crisis and the most aggressive tightening of the Fed's monetary policy in decades? Or will the Fed still manage to make a soft landing? In the first case, the infection risks spreading to the rest of the world, and oil prices will fall. In the second, with support from China, the North Sea variety will definitely rise.

Technically, a 1-2-3 reversal pattern was formed on the Brent daily chart. Its activation is a signal to break the long-term downward trend for oil. The next step of the bulls should be a breakout of resistance at $79.1 per barrel. If that happens, the road to $83 and $87 will be open, and we can finally focus on buying.