For oil bulls, one of the biggest caps on prices this year is turning into a tailwind.

Oil’s 10% drop so far in 2023 confounded some analyst and trader expectations of triple-digit prices as China reopened for business following anti-Covid 19 measures.

Instead, one of the most aggressive rate-tightening cycles by central banks in decades has created a perceived drag on demand, while simultaneously incentivizing traders to sell oil held in storage. That boosted short-term supply to the market at a time when Russian and Iranian oil exports also ballooned.

But now, aided by OPEC+ cuts and those same elevated borrowing costs, inventories are showing signs of starting to decline. With the growing cost of money helping to force barrels out of storage tanks, some bulls now argue the market is nearing a tipping point — setting crude prices up for spikes further down the line.

“Nobody wants to hold inventory, and I think we are, as a world, going toward lower inventory forward cover,” Amrita Sen, co-founder and director of research at Energy Aspects said in a Bloomberg TV interview last month. “If you ask me what did I miss this year it has been the rising cost of capital and what that’s doing to the market, which is destocking.”

The additional costs of storing oil during a period of sustained high interest rates are stark.

Take a two-million barrel cargo with prices at, say, $80 a barrel. Based on an interest-rates at 5%, it would cost a trader an $8 million per year in financing to hold onto the consignment.

That effectively means it costs an extra 30 cents per barrel per month to keep supplies. The disincentive to store is doubled when later oil prices are trading at a discount to nearby ones — a structure known as backwardation, that is present at the moment — because it means traders are forced to sell barrels they had stored at a loss.

Oil refiners, who buy crude and then sell fuels like gasoline and diesel at a later date, also see their profits squeezed by higher financing costs.

It all serves to increase the chances of the world having to get used to lower levels of oil inventories.

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“A higher cost of capital incentivizes de-stocking,” Goldman Sachs Group Inc. analysts including Callum Bruce wrote in a recent note. “The destocking ends once inventories reach a new, lower equilibrium.”

The bank estimated that higher interest rates have pressured key timespreads — effectively the shape of the futures curve — over the next three years by $8 a barrel. It’s the biggest impact of its kind in decades, they added.

Draws Dawning

The bulls — whose optimism has proven misplaced so far this year — argue that large oil stockdraws are about to be upon the market.

The International Energy Agency forecasts demand for OPEC crude and inventories of more than 30 million barrels a day over the second half of the year.

That’s almost 2 million barrels a day more than the group pumped last month. Meanwhile, the US government’s energy research arm also predicts a stockpile decline in the second half.

That fundamental optimism is having to simultaneously battle some of the other — negative — impacts of higher rates.

Since the Federal Reserve’s first hike, oil prices have persistently come under pressure. Minutes from the Fed’s June meeting showed that a large majority of policymakers agreed that more tightening will likely be needed this year.

Alongside concerns that global energy consumption will suffer as economic growth slows, investors have flocked to assets that have higher yield and less perceived risk. A basket of 16 cross-commodity ETFs is on track for its biggest annual outflow since at least 2006, according to data compiled by Bloomberg.

“Investors don’t need to hunt as aggressively for yield as we see in a low interest rate environment,” said Warren Patterson, head of commodities strategy at ING Groep NV.

This week, the leaders of OPEC+, Saudi Arabia and Russia doubled down on efforts to tighten the market, pledging continued reductions in supply next month. Alongside signs of inventory declines in the US, the bulls argue that a period of market strength is on the horizon.

The question now, is whether higher interest rates will bolster that strength by emptying storage tanks.

“There are higher holding costs, it’s kind of obvious right,” said Gary Ross, a veteran oil consultant turned hedge fund manager at Black Gold Investors LLC. “You don’t want to build inventory with a limping Chinese economy and interest rates rising. We’ve had no choice because supply was greater than demand, but now we are drawing stockpiles.”

(Updates with minutes of latest Fed meeting in 17th paragraph.)