End of Year Oil Summary and Outlook for 2024

It is that time of year again, when the mind of every trader, investor, and analyst turns to what the next year will bring. In late December even those like me, people whose trades usually have time horizons measured in hours or days at most, peer into our crystal balls and try to predict where things will be a year from now. In some ways, that may seem like a bit of a pointless exercise, but stepping back and formulating a long-term view and strategy is never a bad thing. It encourages a rational, dispassionate look at overall circumstances. Providing you understand that new information can and usually will change your view, that can be helpful to fall back on when things start flying around.

Ironically, in order to look forward, though, you first have to look back. In this context, I am not talking about analyzing the chart to find relevant levels, although that should be done as a matter of course, but rather looking at long-term trends and what caused them.

The most significant moves in 2023 were the run up to above $90 and the subsequent drop back to below $70 that we saw in the second half of the year. That kind of volatility is not unusual in oil, but what was interesting this time was that those moves didn't necessarily follow conventional wisdom about economic conditions and prospects. That becomes clear when you look at a chart comparing the S&P 500 tracking ETF, SPY, the blue line below, with USO, the green line, which tracks WTI…

Oil climbed early in the second half as stocks weakened, then fell back later when stocks rebounded. That suggests that neither move in crude was about economic prospects, which is usually what drives the stock market. It seems, therefore, that oil prices were moving based on supply conditions more than anything. That makes sense, and if supply can dominate the narrative to that extent and for that long with an uncertain growth outlook, there is no reason to think that that will change any time soon.

So, the key to oil next year is the supply side of the equation, and the outlook there is bullish, at least for early in the year. OPEC+ is holding together and the countries involved have shown a willingness to keep supply tight, while the Israel/Gaza war and increasing Houthi activity in the Red Sea have not only disrupted supply from the Middle East, but also raised the stakes. The Houthis are largely funded by Iran and are believed to do their bidding in most cases, so their increased activity hints at the kind of broadening of the conflict that has scared so many people but has so far been avoided. In order to keep your sanity, you must assume that the worst case scenario won't play out here, but increased tension and uncertainty look very likely in the first quarter or so of next year.

The pullback in oil in the face of increasing optimism about the economy that we saw in Q4 of 2023 was largely about increasing supply in North America, but there too, the logical outlook for next year results in a bullish scenario for oil. 2024 will be a Presidential election year, and the uncertainty that always comes with that, let alone right now with such polarization, discourages long-term drilling projects in America. That makes any further big increases in US output unlikely before the election in November.

There is a possible bear case too, of course, but that revolves mainly around the US, or maybe the world, falling into a recession that causes a collapse in demand for oil. That is still a possibility, but evidence pointing to a soft landing for the US economy has been growing. The jobs market and consumer spending have been holding up as inflation has dropped. That suggests that maybe the Fed has got it just right, and markets other than oil are pricing in lower interest rates not prompted by severe weakness.

For now, the focus of the oil market remains on supply rather than risks on the demand side. That looks unlikely to change early next year unless the economic picture changes dramatically, and it is hard to see how that can be anything but positive for oil. So, I will go into the new year with a bullish view on crude, albeit with a wary eye on economic conditions and an awareness that a shift of focus amongst oil traders to the demand side of the equation could cause weakness.

Wherever crude goes, though, and whatever other markets do, 2024 will be a year when alertness and agility will be key to successful trading and investing, so I would like to wish you a merry holiday season, and a happy, alert, and agile new year!