US Crude Futures Experience Unprecedented Plunge, Market Remains Puzzled Amid Liquidity Concerns

US crude futures took a surprising 7.2% plunge in the first minutes of trading on Thursday. West Texas Intermediate (WTI) plummeted by nearly $5 a barrel for a few seconds before recovering, while global benchmark Brent remained relatively stable. This sudden drop raised questions about the health of liquidity in the market, particularly since the move was concentrated in WTI.

Various factors have been suggested as possible explanations, including speculators abandoning bullish bets, a fat-finger trade, algorithmic selling, and a giant options position that now appears to be loss-making. The rapid decline and swift recovery is the latest wild swing in the global oil market, with prices experiencing turbulence over the last six weeks due to OPEC+ supply cuts, slower global growth, and US banking concerns.

The drop occurred in early Asian hours, which typically sees thinner trading volumes. However, the timing was unusual, as sharp moves generally happen right at the open, as was the case with the surge following the recent OPEC+ reduction. This time, the price shift took a few minutes to materialize.

Oil futures endured a roller-coaster ride as Chinese traders returned after a break, first collapsing to the lowest level since December 2021 before erasing losses to trade higher. This was attributed to panic selling, amplified by algorithmic trading, and possibly fat-finger errors or speculators abandoning bullish bets.

Oil has retreated 14% this year, indicating that OPEC+ efforts to control the market through output cuts have not yet been effective. Losses have been driven by concerns of slowing global growth, potentially impacting energy demand. ANZ Group Holdings Ltd. analysts Brian Martin and Daniel Hynes predict sentiment will remain bearish in the oil market.

Oil has also faced pressure in 2023 due to resilient Russian flows, despite Moscow's vow to reduce supplies and Western sanctions following the invasion of Ukraine. The US crude benchmark's prompt spread has narrowed sharply in recent weeks, signaling traders expect conditions to loosen.

Despite falling crude oil inventories, WTI and Brent prices have plunged. This dislocation is likely temporary and occurs when prices are influenced by other oil market fundamentals, expectations, broader asset markets, and financial flows. Optimism regarding OPEC+ production cuts has failed to counter concerns about demand linked to a weakening economic backdrop and a hawkish Federal Reserve.

Goldman Sachs advises investors to buy energy and mining stocks, as they are positioned to benefit from China's economic growth. Their commodities strategist forecasts Brent and WTI crude oil will climb 23%, trading near $100 and $95 per barrel over the next 12 trading months. This supports their positive view of profits in the energy sector.

Energy stocks remain significantly undervalued, and the outlook for the sector remains bright. Moody's research report predicts that industry earnings will stabilize in 2023, albeit slightly below 2022 levels. Prices are expected to remain cyclically strong, supporting cash flow generation for oil and gas producers.

StanChart analysts predict that OPEC+ cuts will eventually eliminate the surplus in global oil markets, which began building in late 2022 and continued into Q1 2023. They estimate that oil inventories are currently 200 million barrels higher than at the start of 2022 and 268 million barrels higher than the June 2022 minimum. If cuts are maintained throughout the year, the analysts believe the surplus could be gone by November, or by the end of the year if cuts are reversed around October.