The surge in oil prices caught some by surprise, but many observers had been warning for months of such an outcome, especially as the IEA repeatedly forecast market tightening in the second half of the year. Post-pandemic economic growth is expected to raise demand, OPEC+ quotas are restricting supply, war in the Ukraine has made Russian exports uncertain, and U.S. shale production appears to be slowing. What perplexed many is that all of this has been forecast for months but prices did not respond until recently.
Of course, things have not played out as predicted by the IEA (note, they never do and never will, and not just for the IEA but everyone). The table below compares the IEA’s forecast from the January and September Oil Market Reports for Russian oil supply and Chinese oil demand and the revisions are significant—but offsetting. Russia supply is running about 1 mb/d ahead of earlier expectations, while Chinese demand is also about 700 tb/d higher.
The latter is particularly surprising given the drumbeat of bad economic news from China, including stories about high youth unemployment, struggling real estate firms, and weak consumer sentiment and spending. The robust nature of demand could indicate that the government has yet another rabbit of stimulus to pull out of what seems like a bottomless hat but could also reflect either inventory building by Chinese oil companies and/or high petrochemical demand, which could be geared towards export markets.
And while Russian oil exports have confounded the IEA’s expectations, there were many skeptics who felt that the organization was giving too much credence to the possible impact of sanctions and the oil price cap. Of course, weaker prices this year kept Russian oil prices under the cap, but it doesn’t seem likely that current higher prices will slow exports. If anything, the Russians have more room to increase their sales prices, which would encourage higher, not lower, exports. It is hard to imagine Putin foregoing easy money, given the growing economic problems he’s facing.
On the bearish side, production will almost certainly creep up from the two ‘pariah’ nations of Iran and Venezuela, partly from better evasion of sanctions but also because the Biden Administration is making (admittedly glacial) progress towards easing sanctions on the two. However, the volumes are likely to grow slowly, mostly offsetting production declines elsewhere in OPEC+.
But the bull case is very much supported by the global inventory levels. The IEA notes that most of the increase in global stocks this year has been in China, which sounds scary until you realize that most of the demand growth this year is also in China. (Figure below) OECD inventories at end August are higher than a year ago (next figure) even as demand is flat, which is hardly bullish.
On the other hand, U.S. inventories, the most timely and presumably accurate data, have been falling of late (figure below), at least for crude and gasoline. However, these are not unusual declines, although they appear severe and certainly indicate some tightening, perhaps because Asia is absorbing exports. Even so, crude inventories in particular are not dropping sharply compared to refinery runs, as the second figure shows.
While much of the recent commentary has focused on the failure of a recession to appear as so many anticipated, bear in mind that oil market forecasts always assume economic trends will continue. No recession is factored into official forecasts until well after they have developed. That oil forecasters are unable to foresee downturns is hardly surprising, given the inability of central banks to do the same, but it means that market tightening next quarter is partly contingent on no significant economic weakness. Should Chinese bankruptcies, U.S. labor action, and inflationary pressures from already high oil prices have a greater impact than now expected, the likelihood of prices remaining above $100 seems small.
Still, prices could easily remain above $90 a barrel absent some deviation from these trends, most probably either peace in Ukraine (one way or another), or a decision by that perennial wild card Saudi Arabia to increase production and moderate the price. Nothing to date suggests that they will, but then most of us didn’t expect the production cuts they adopted this year. And while recent history implies a desire for higher rather than lower prices, they also have shown a willingness to defend market share in the past (1986, 1998, 2014).
Certainly, the idea that the Saudis would sit idly by if we saw a repeat of the 2008 oil price bubble (ancient history I know) seems improbable. But the question is: if the current price is based (in part) on momentum trading, what will be the trigger to reverse that? A Saudi pronouncement leads the list, followed by some strong, negative economic news, and of course peace in the Ukraine. Shale oil producers remain a joker in the pack (and based on the oilmen/women I know, they are jokers); if drilling and production pick up enough to threaten Saudi market share, the experience of 2014 could well be repeated.
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