Oil's Rally Faces Crosscurrents: Can the U.S.-China Truce Sustain Gains?

The price of Brent crude has clawed back to $74/barrel this week, near seven-week highs, as traders bet that a fragile U.S.-China trade truce and OPEC+'s disciplined supply management will stabilize demand. But beneath the surface, the market is a tangle of competing forces: unresolved trade tensions, structural shifts in Chinese oil consumption, and OPEC+'s precarious balancing act between production cuts and market share.

The U.S.-China Truce: A Near-Term Bump, Not a Long-Term Fix

The "framework agreement" reached in London—easing restrictions on Chinese rare earth exports and delaying U.S. auto tariffs—has reduced the immediate risk of a trade war escalating into a demand collapse. Traders are now pricing in a 1-2% uplift in global oil demand growth for 2025, thanks to improved supply chain stability and a modest rebound in Asian manufacturing activity.

However, the deal lacks teeth on critical issues like semiconductors and export controls, leaving China's oil demand growth vulnerable to deeper structural headwinds. S&P forecasts Chinese oil demand growth will slow to just 1.7% this year, compared to pre-pandemic averages above 3%, as EV adoption (now over 50% of new car sales) and a real estate slump drag on diesel consumption.

The World Bank warns that unresolved trade frictions could still shave 0.5% off global growth, with trade volumes growing at a meager 1.8% in 2025—half the pre-pandemic rate. In short, the truce buys time but does nothing to resolve the megatrends undermining oil's long-term fundamentals.

OPEC+'s July Hike: A Risky Gamble on Compliance

OPEC+'s decision to add 411,000 b/d of production in June—its second consecutive monthly increase—was a calculated gamble. The group aims to reclaim market share without triggering a price collapse, but risks are mounting:

1. Compliance Risks: While Saudi Arabia and Russia have adhered to quotas, smaller producers like Iraq and Kazakhstan have overproduced by 100-200 kb/d in recent months. A July production hike could strain compliance further, flooding the market if non-compliance spreads.
2. Inventory Overhang: The EIA projects global inventories will rise by 800,000 b/d in 2025, with U.S. crude stocks already at 7% below the five-year average—a level that could easily turn into a surplus if demand falters.
3. Saudi Dilemmas: Riyadh faces a political-economic tightrope: it needs $85/bbl to balance its budget but risks a price war if it pushes too hard to offset U.S. shale growth (which the EIA now forecasts will grow only 180 kb/d in 2026, down from earlier estimates).

Inventory Data: A Mixed Signal Amid Macro Storm Clouds

Last week's EIA report showed a 0.4 mb decline in U.S. crude inventories, a modest draw that traders interpreted as bullish. But dig deeper, and the data is ambiguous:

• Gasoline Stocks Rose 5.2 mb, signaling weaker summer demand than expected.
• Distillate Inventories Remain 16% below the five-year average, reflecting lingering industrial weakness.
• Refinery Utilization hit 93.4%, a positive sign, but gasoline margins have collapsed to $0.15/gallon, squeezing refiners' profitability.

Meanwhile, macro headwinds loom:
- The IMF has cut its 2025 global GDP forecast to 2.8%, with advanced economies like the U.S. facing 1.4% growth—a pace that risks recession in late 2025.
- China's real estate-driven slump continues, with cement production (a proxy for construction activity) down 8% year-on-year in May.

Investment Strategy: Position for Volatility, Not a Bull Run

The market is in a precarious equilibrium. Near-term catalysts—like a July OPEC+ deal that sticks to cuts or a stronger-than-expected China PMI—could push prices toward $80/bbl. But structural risks (EV adoption, shale resilience, trade wars) remain unresolved.

Recommendation:
- Adopt a neutral-to-cautious bullish stance: Use 10-15% of capital to bet on $70-$75/bbl rallies, with stop-losses below $68/bbl.
- Hedge downside risk: Pair long positions in oil ETFs (e.g., USO) with short-dated put options to protect against inventory surpluses or geopolitical flare-ups.
- Focus on resilient sectors: Petrochemical firms (e.g., LyondellBasell (LYB)) and LNG exporters (e.g., Cheniere Energy (LNG)) benefit from stable demand even if crude prices stagnate.

Conclusion

Oil's rally is a flicker of hope in a stormy market. While the U.S.-China truce and OPEC+ discipline provide short-term support, long-term demand fundamentals—driven by EVs, weak Chinese growth, and oversupply—are still deteriorating. Investors should treat this as a tactical opportunity rather than a buy-and-hold signal. Monitor EIA inventory data weekly and stay vigilant for geopolitical triggers—any escalation in U.S.-China trade talks or OPEC+ non-compliance could turn this rally into a rout.