The global benchmark oil price has been stuck near $75 a barrel since May. Crude oil prices won’t stay there forever, but anyone betting on where they go next should understand the complex pressures weighing on oil markets at the moment, including the resurgence of the U.S. shale sector.
The media have offered a relatively simple explanation for why oil hasn’t broken out of its narrow trading range. Fears of global economic slowdown and the knock-on effects on oil demand are effectively offsetting supply cuts by members of the Organization of the Petroleum Exporting Countries and its allies (OPEC+), they say.
Bearish sentiment about the economy – particularly China, the most important hub of demand growth – is real. The World Bank recently forecast economic growth of 2.1% this year, down from 2022’s 3.1%, citing persistent high inflation and rising interest rates.
But most leading oil market analysts and banks still expect a significant surge in oil demand in the second half of the year as consumption of petroleum products continues to recover from the pandemic. The International Energy Agency (IEA) projects world oil demand to grow by 2.4 million barrels per day in 2023 to 102.3 million barrels a day – a new record – with nearly all of that growth coming in the second half of the year.
Combined with recent pledges from the OPEC+ cartel to reduce output by 1.1 million barrels a day to support a higher-price environment, we should expect big draws in global oil inventories that will lead to a tightening of oil markets in the coming months.
Not everyone is buying this narrative, though. Banks and investment funds typically quickly follow the macroeconomic sentiment in all asset classes, including oil, much of it via algorithm trading. And sentiment for any asset outside of “Big Tech” and Artificial Intelligence has been weak this year.
The same macro malaise has trapped oil. The futures market recently flirted with a bearish – an expectation that prices will fall – structure known as contango, where the futures price for oil is higher than the immediate delivery price. When the oil market is in contango, it encourages traders and refiners to put oil in storage tanks and hold it into the future when it will be worth more. And excess inventories weigh on prices.
Speculative traders like hedge funds and banks can greatly impact oil price futures, especially in today’s thinly traded market.
At some point, though, oil will stop trading on macro sentiment and respond more directly to supply-and-demand fundamentals.
The general consensus going into this year was that oil was headed back to $100 due to the anticipated demand boom and OPEC’s aggressive supply management. That scenario is looking far less likely now. Some now worry that oil balances may not be as bullish in the coming months as the IEA and others anticipate.
Dismal Chinese manufacturing data has caused raised eyebrows about the much-needed demand boom in the second half of this year. At the same time, global supply remains strong as Russia defies expectations that sanctions and price caps will hurt its production and export volumes.
To be sure, Russia, a critical member of the expanded OPEC+ price coalition, has vowed its exports will fall by 500,000 barrels a day starting in August. Moscow may have decided to prioritize higher prices over volume, but Russia’s oil trading has gone dark to circumvent Western sanctions, and it’s anyone’s guess how it will behave next month. The Kremlin could be trying to talk up oil prices without sacrificing export volumes as it tries to plug a budget gap blown wide open by the escalating cost of it’s war against Ukraine.
But it’s not just Russia that’s a problem on the supply side. Oil exports from Iran and Venezuela – OPEC+ members also facing Western sanctions – are up this year, contributing to a burgeoning shadow market for oil in Asia.
Outside the cartel, the United States, Canada, Guyana, and Brazil could add enough oil to satisfy more than 80% of the forecasted demand growth this year. U.S. oil production is set to break records. Domestic output through April was up 9% over last year’s levels thanks to continued efficiency by shale producers.
That suggests a well-supplied oil market – even if grim economic fears don’t materialize.
That puts the onus on Saudi Arabia and other OPEC+ producers to step up and make further supply cuts. But getting these countries to agree to curtail their most significant budget input after three rounds of cuts since October won’t be easy.
Riyadh might push the issue regardless since the Saudi budget needs an oil price of around $80 to balance its annual budget. But it’s not guaranteed that further OPEC+ cuts would even succeed in pushing up prices.
That’s because the more the allied cartel cuts, the more spare production capacity the global oil market gains. OPEC+ spare capacity is already back to nearly 4 million barrels a day, a solid cushion for a market in full crisis mode only a year ago. The current situation once again raises questions about OPEC’s ability to manage oil markets, especially as America’s scrappy shale sector continues to surprise energy watchers.
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