MW Why oil's rally after Russia's 'Pearl Harbor' moment may be short-lived

By Myra P. Saefong

'Geopolitical crisis arbitrage' tends not to have long legs, says SPI Asset Management's Stephen Innes

Geopolitical shocks have a knack for roiling the financial markets, but the oil sector was still caught off guard by a surprise attack by Ukraine that has been referred to as "Russia's Pearl Harbor," and which led to an unexpected rally in crude prices that some analysts believe is doomed to be short-lived.

The upward move in prices came during the same weekend that OPEC+ announced a decision to speed up its production increase for a third month in a row. Some analysts had expected to see oil move lower in the wake of that decision, but that was before Ukraine's drone strikes on Russian air-force bases that damaged or destroyed bombers used by Russia for missile attacks and potential nuclear strikes, according to the Wall Street Journal.

Ukraine's recent drone strikes on Russian air bases have "introduced a renewed element of supply risk into the [oil] market," said Alex Hodes, director of energy-market strategy for StoneX, in a Monday newsletter. This geopolitical backdrop provided "an offset" to the news that OPEC+ would raise production by 411,000 barrels per day in July, "a move widely anticipated and already priced in by traders."

Eight countries in the group, comprised of the Organization of the Petroleum Exporting Countries and its allies, made the announcement on Saturday, accelerating the return of a total of 2.2 million barrels in voluntary production cuts that had been implemented in January 2024. They had been gradually returning those barrels of oil to the global market since April.

By July, OPEC+ will have returned to the market 1.37 million barrels per day of the 2.2 million bpd of voluntary cuts, according to strategists at Société Générale, who believe that the expedited output increases convey "aggravation" against persistent overproduction by members of the group who have not fully complied with output quotas.

From a market-outlook perspective, Société Générale estimates that the additional supply increase - assuming a continued but more gradual return of barrels starting in August - will flip the Brent curve into a full one-month to 12-month contango with six months, the strategists said.

That's a situation where futures prices for crude are higher than the current spot prices, and can imply that there's more supply than needed to meet demand.

Bears vs. bulls

"Bears had been in control for too long, so today's market move puts focus back on fundamentals rather than sentiment," said Manish Raj, managing director at Velandera Energy Partners.

Expectations for more oil supply in the global market, along with uncertainty surrounding the outlook for oil demand, has pulled oil prices down year to date.

Brent short positions were at their highest since October before the OPEC+ decision was made, according to Hodes, who said that suggested the market had baked in the downside of the decision already. That, paired with rising geopolitical tensions, allowed for the oil market to move significantly higher Monday, he said.

Even so, Velandera Energy does "not see a sustained rally here, barring any news in supply constraint," Raj told MarketWatch. "Oil bulls once bitten are twice shy, so bosses are asking traders to wait and watch before putting money to work."

This is likely a "relief rally" where portfolio managers are "marking up their inventory rather than deploying new capital into crude," Raj added.

Oil prices were up sharply Monday, with the July contract for U.S. benchmark West Texas Intermediate crude (CL.1) (CLN25) up $1.80, or 3%, at $62.59 a barrel on the New York Mercantile Exchange. Global benchmark Brent crude saw its new front-month August contract (BRNQ25) (BRN00) trade at $64.59 on ICE Futures Europe, up $1.81, or 2.9%. Both had settled Friday at their lowest levels in about three weeks.

"Oil is trading as if it has just remembered that geopolitics exists," said Stephen Innes, managing partner at SPI Asset Management, in a note Sunday.

Read: Oil prices jump despite OPEC+ announcing another sharp production hike

Russian media and some pro-Moscow bloggers have emphasized the seriousness of the situation, branding Ukraine's latest attack as "Russia's Pearl Harbor," news reports said.

This is 'all geopolitical crisis arbitrage, which tends not to have long legs.'Stephen Innes, SPI Asset Management

"It's a balancing act between barrels and bombs, where the smallest misstep could trigger a bigger flight to long hedging," said Innes, referring to Russia-Ukraine developments.

This is, however, "all geopolitical crisis arbitrage, which tends not to have long legs," he added.

WTI and Brent crude were both down from the session's best levels on Monday afternoon, after a climb in WTI of as much 5.1% from Friday's settlement.

Michael Lynch, president at Strategic Energy & Economic Research, dubbed the geopolitical premium on the upside for prices as "minimal."

Peace in the Middle East is far off, but the Houthi threat to oil shipping routes in the region "seems much diminished," he told MarketWatch. "More sanctions are Russia are possible, but so far they have had minimal impact on their exports, which is likely to continue."

The bigger threat that could lead to lower oil prices is the possibility of a nuclear agreement with Iran, which "would mean a little more oil, and some increase in bearish sentiment," said Lynch.

And even more worrisome is "growing economic uncertainty, which is probably going to affect demand later on," possibly in the third quarter, he added. "Combined with a probable increase in Saudi production, the momentum should be bearish" for oil for the rest of the year.

-Myra P. Saefong

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

June 02, 2025 15:22 ET (19:22 GMT)

Copyright (c) 2025 Dow Jones & Company, Inc.