Oil prices rise on Fed rate cut hopes

Oil prices saw a modest uptick on Monday as investors focused on the potential for interest rate cuts by the U.S. Federal Reserve, though gains were limited by the resumption of U.S. supply following recent disruptions.

Brent crude futures for November delivery rose 15 cents, or 0.2%, to $71.76 a barrel in early trading. Meanwhile, U.S. West Texas Intermediate crude for October delivery climbed 23 cents, or 0.3%, to $68.88 per barrel.

The slight price increases come as markets look ahead to the Federal Reserve's upcoming policy meeting on September 17-18, with growing expectations for a rate cut in the near future.

Fed Rate Cut Expectations Buoy Oil Sentiment

A key factor driving oil prices this week is speculation around how aggressive the Federal Reserve may be in cutting interest rates. Fed fund futures indicate investors are increasingly betting on a 50 basis point cut rather than a more modest 25 basis point reduction.

Lower interest rates tend to stimulate economic activity by reducing borrowing costs. This in turn can boost demand for oil and other commodities. As such, the prospect of rate cuts is providing some support for crude prices.

"We remain in the gradualist camp and expect the Fed to begin cutting by 25 basis points," noted analysts at ANZ.

However, some experts caution against expecting an outsized rate cut at this stage. Arnab Das, Global Macro Strategist at Invesco, commented:

"We have and I have been in the 25 bps camp all along; 50 basis points are possible, but is unlikely at this stage. The market was pricing more like 30 bps before the CPI. Although the headline CPI number is fine, the core number is not as good as hoped, and core PCE will maintain that story. We are looking at a 25 bps cut."

Mixed Signals on Oil Demand Outlook

While rate cut expectations are providing some upward momentum, the overall demand picture for oil remains mixed. This is limiting more substantial price gains.

Recent data from China, the world's largest oil importer, showed industrial output growth slowed to a five-month low in August. Retail sales and new home prices also weakened further. Additionally, Chinese oil refinery output fell for a fifth consecutive month amid disappointing fuel demand and weak export margins.

The International Energy Agency (IEA) recently reported a slowdown in global oil demand growth to 710,000 barrels per day year-on-year in the second quarter - the slowest increase since late 2022. This was primarily due to declining Chinese consumption.

Looking ahead, the IEA projects global oil demand growth will average slightly below 1 million barrels per day in 2024. This more conservative outlook is based on expectations of moderate economic growth, increased energy efficiency, and rising electric vehicle adoption.

In contrast, OPEC maintains a more optimistic view, forecasting demand growth of 2.2 million barrels per day for 2024. The oil producer group cites expectations of 2.9% global economic growth this year as supporting increased consumption.

Supply-Side Factors in Focus

On the supply side, nearly a fifth of crude oil production and 28% of natural gas output in the U.S. Gulf of Mexico remains offline in the aftermath of Hurricane Francine. However, production is gradually resuming, which is tempering more significant price increases.

The weekly U.S. rig count also showed an increase, suggesting the potential for rising domestic production in the coming months.

OPEC+ production cuts continue to play a key role in supporting prices. The group's latest agreement, announced on November 30, included 2.2 million barrels per day of new voluntary cuts to its crude oil production target through March 2024.

Geopolitical Tensions Add Uncertainty

Geopolitical factors are injecting additional uncertainty into oil markets. Israeli Prime Minister Benjamin Netanyahu stated Israel would inflict a "heavy price" on the Iran-aligned Houthis after they reached central Israel with a missile for the first time on Sunday.

Any escalation of tensions in the Middle East has the potential to disrupt oil supplies and drive prices higher. However, the impact of geopolitical events on oil markets has evolved in recent years.

Arnab Das of Invesco noted:

"The bigger story is that OPEC oil producers despite all the geopolitical tensions, the open conflict in the Middle East and the open conflict between Russia and Ukraine, actually because of those conflicts at least to some degree the major oil producers including Russia, Saudi, because of its desire to diversify the economy, probably all want to pump more oil rather and generate more oil revenues than cut back on oil production, oil supply, as had been the case with geopolitical conflicts affecting the oil market, in the 70s and early 80s where there were embargoes from the oil producers."

Outlook for Oil Prices

While oil prices are seeing some upward momentum on rate cut hopes, analysts generally do not expect dramatic price surges in the near-term given the mixed demand signals.

The U.S. Energy Information Administration (EIA) forecasts Brent crude oil prices to average $82 per barrel in 2024 and $79 per barrel in 2025, close to the 2023 average of $82 per barrel.

"Our forecast for relatively little price change is based on expectations that global supply and demand of petroleum liquids will be relatively balanced," the EIA stated.

However, the potential for supply disruptions remains a key risk that could drive prices higher. The EIA noted, "The potential for prices to exceed our current forecast is largely related to unplanned production disruptions, a risk highlighted by the recently escalating tensions in the Red Sea."

Arnab Das of Invesco echoed this sentiment, stating:

"I do not think we are going to have a big collapse in the price of oil. The big surges and the big collapses in the price of oil tend to come from the supply side rather than demand-side kind of behaviour which in the major economies tends to be a more gradual process than supply shocks."

Oil prices are inching higher as markets anticipate potential interest rate cuts from the Federal Reserve. However, gains remain limited by mixed signals on oil demand and the gradual resumption of U.S. supply following recent disruptions.

While geopolitical tensions add an element of uncertainty, analysts generally expect oil prices to remain relatively stable in the near-term, barring any major supply shocks. The interplay between monetary policy, global economic growth, and oil market fundamentals will continue to shape price movements in the coming months.

Investors and industry stakeholders will be closely watching the Federal Reserve's upcoming policy meeting for signals on the future direction of interest rates and their potential impact on oil demand and prices.