The price of Brent fluctuated amid a series of market-moving events over the last couple of days, but the headlines struggled to explain what was going on. US President Donald Trump announced new deployments to the Middle East, but Brent dipped below $100 per barrel on Friday. Prior to that, press reports showed more crude was leaving through the Strait of Hormuz, but crude prices rose.
The somewhat erratic moves in the price of crude, and other assets affected by higher energy prices like gold, the dollar and the euro, are likely due to other factors than what the headlines are pointing to. As the war goes on, oil markets are coming under increasing strain, especially heading into the high winter consumption period. At the same time, markets are also adjusting to the new reality. In these conditions, behind-the-scenes factors can have a bigger influence and leave traders confused.
The China Phenomenon
On Thursday, reports that Chinese refiners suspended fuel exports for the month of October were an important factor in the market. There was no formal announcement, making the matter harder for the market to internalize. The issue is that an important part of the impact from the war in the Middle East has been absorbed by China.
The Asian Giant had massive crude reserves before the war started and was the largest consumer of Persian Gulf-sourced crude. China has been running down its reserves to help plug the gap. It has also cranked up exports of refined products, filling the gap in diesel and gasoline production that the war had curtailed.
While this has helped stabilize the market, China doesn’t have unlimited supply and remains the world’s largest crude importer. Traders worried that the suspension of exports was due to falling reserves.
The Real Problem Is Diesel
One of the reasons that the US is particularly affected by the war despite being a net exporter of crude is that it has limited refining capacity. In fact, the US exports crude to Europe to be refined, and then reimports it as diesel, in particular.
Diesel prices spiked in the US as Europe saw a supply crunch in diesel and kerosene. Europe was willing to pay more to keep the distillates it was producing.
The high price of distillates made it more convenient for Chinese refiners to export. However, as prices have moderated and input costs have increased, the reduction in Chinese exports seems to be a result of pricing, not a lack of supply.
This helped the market calm down despite rising geopolitical tensions.
Is the Escalation Real This Time?
Once again, Trump is promising to “hit them hard” when referring to Iran, announcing new military assets being sent to the Middle East. However, analysts noted some notable differences from prior announcements.
First, the US is positioning three carrier strike groups in the region. This is the largest build-up in forces since the start of the war. Secondly, the US is deploying the USS Makin Island Amphibious Readiness Group, along with a contingent of Marines.
This is the typical first unit used to land troops. The ships would be in place by early November, just after the Midterm elections.
Whether this is part of a pressure campaign on Tehran or Trump actually plans on “boots on the ground” in some capacity after the elections, only time will tell. But the market is likely to react if the possibility becomes more real.
