Crude Oil Bottom Line - WTI August futures traded in a $9 range this week, but ultimately arrived at $109.06/Bbl, near where it was last Friday.
The topics moving the oil market this week were familiar ones, but with some twists. Geopolitical tensions related to Russia-Ukraine, of course, continued. But Libya’s outages (around 0.7 MMBbl/d) and Ecuador’s force majeure related to fuel protests (0.2 MMBbl/d) added some bullish force to prices.
Meanwhile, economic worries keep a lid on prices as demand is uncertain. AEGIS notes that some industrial fuels (e.g. diesel) already seem to be showing weakness. Is it a temporary blip, or a leading indicator?
We still think that suppliers of crude are going to find difficulty meeting global demand growth in 2H2022 and 2023. OPEC’s production is struggling to meet quotas. Russia crude is being avoided by Western economies. U.S. investment is insufficient to return to a pre-2020 growth trajectory and supply the world.
Therefore, there is more upside risk to prices through 2023, in our view. How should producers hedge it? Use structures that protect against surprises, but only minimally restrict you to higher prices. The most cash-efficient way to do that is through costless collars (buy a put option, and sell a call option). For consumers of crude-linked products, such as diesel: note that the forward curve offers you a steeply discounted price, compared to spot. Swaps are a highly effective way to lock-in lower prices and control the fuel expense.
To see details on factors we believe are affecting oil prices and trade recommendations, click the "Read More" button on the Factor Matrix section in the AEGIS Research Module
Crude Oil Factors
Geopolitical Risk Premium. (Bullish, Surprise) We decided to add this new factor, considering the recent turmoil hitting several countries in the eastern hemisphere. Most of the headlines are dominated by the Russian invasion of Ukraine and it has been the driving factor of the prices. Concerns of supply constraints grew following the sanctions by the U.S. and UK. The European Union approved a sixth set of sanctions, including a partial ban on Russian oil imports after Hungary waived concerns that had been holding up the decision for weeks.
Iran. (Bearish, Surprise) The Iran nuclear talks ended in early March without a resolution, jeopardizing discussions progressing toward a resolution. The possibility of an end or reduction of Iran sanctions poses a downside risk to oil prices. This is one of the bearish non-economic factors that could pressure oil prices in 2022. Iran's oil exports surged to 870 MBbl/d in the first three months of the year, up 30% from an average of 668 MBBL/d for the whole year of 2021 (Kpler). Iran's production has risen to about 3.8 MMBbls/d in the expectation of sanctions being eased in the near future. Some analysts estimate Iran is already exporting roughly 1 MMBbl/d despite the sanctions and doesn't disclose data for its official oil exports.
Russian Supply. (Bullish, Priced In) The Russian invasion of Ukraine has not yet resulted in a shortage of oil on the market. Despite this, prices escalated because of the news, mainly to fears that sanctions against Russia will stifle energy exports. It is presently unknown how sanctions would affect energy flows or how long any potential supply disruptions will continue. Russia's total petroleum exports are estimated to be around 8 MMBbl/d, and the absence of even a portion of this supply, given that Russia is the world's third-largest supplier of oil, would be a significant influence in driving up prices. According to shipping data and some analysts, China is quietly ramping up purchases of oil from Russia at bargain prices, with China's seaborne Russian oil imports hitting a near-record 1.1 MMBbl/d in May, up from 750 MBbl/d in the first quarter and 800 MBbl/d in 2021.
Oil Inventories. (Bullish, Priced In) Oil inventories in both the U.S. and abroad are extremely low. Crude data is usually on a several-month lag. IEA data shows that OECD inventories were at a seven-year low in November. Since then, the oil market has likely remained in a supply deficit, so inventories are surely lower now, as evidenced by the massive backwardation in the forward curve. According to several shops, the global supply-demand balance is likely to hit a surplus at some point in 2022; however, volatility will likely be heightened with inventory levels at inadequate levels to serve as a "shock absorber" for prices.
Supply Chain. (Bullish, Priced In) U.S. producers are struggling with supply chain disruptions, such as a shortage of workers, and equipment, a scarcity of sand for fracking operations, and high metals prices, to take advantage of increased global demand and high oil prices. These constraints could influence driving the prices up.
Government Intervention. (Neutral, Priced In) The United States announced the largest release from the Strategic Petroleum Reserve, totaling 180 million barrels or 1 million barrels per day over a six-month period beginning in May, which was the biggest mover in prices. This comes after the U.S. announced that it would release 30 million barrels from the Strategic Petroleum Reserve in early March. In addition to this, the IEA member countries announced another 120 million barrels, including the U.S.'s share of 60 million barrels. These SPR releases aim to reduce supply disruptions; therefore, they have a short-term bearish effect on oil prices. U.S. DOE announced plans to buy back 60 million barrels for the Strategic Petroleum Reserve.
Economic Slowdown. (Bearish, Surprise) Higher global energy prices might increase the potential for an economic slowdown. Macroeconomic uncertainties could pressure oil demand, and therefore oil prices in 2022. According to the EIA, U.S. real GDP declined by 3.4% in 2020, and they estimate U.S. GDP increased by 5.7% in 2021. They forecast GDP will rise by 2.2% in 2022 and by 2.3% in 2023. While that doesn't sound all too bad, the main takeaway is that crude oil demand growth would likely slow with GDP, and if supply growth outpaces demand growth, then you would find yourself in a structurally weaker market. U.S. CPI reached its highest level in more than 40 years at 8.6% in May and with the S&P 500 down about 14% year to date are increasing concerns about an economic slowdown.
OPEC+ Quotas. (Bullish, Surprise) The group plans to bring approximately 650 MBbl/d of additional supply into the market from July through September. This policy, which had been in place since mid-2021, has been revised in light of a decline in Russian output due to additional sanctions. Since the pandemic began, OPEC has managed oil markets very conservatively and allowed global inventories to be depleted, which has supported oil prices. Recently, the narrative has changed, and many analysts are now questioning how much spare capacity the group really has left. Several countries such as Angola and Nigeria have underperformed relative to their quotas. These shortfalls have exacerbated recent market tightness.
COVID-19. (Bearish, Priced In) An outbreak of COVID-19 resulted in massive lockdowns in China resulting in reduced crude demand in the nation. After six weeks of strict lockdowns, Shanghai started gradually easing the lockdowns. As the country emerges from a prolonged period of lockdowns, its oil demand is expected to rise, putting extra strain on a market that has already tightened dramatically since Russia invaded Ukraine. It seems most countries have learned how to live in a post-COVID world where the virus has become a daily part of life. The arrival of the Omicron variant initially shook confidence in the demand recovery, but the strain has proved to be relatively mild. Further, global consumption has been notably resilient despite the huge increase in the number of infections. Updates on Chinese lockdowns as a result of the latest outbreak have been a major moving factor in recent weeks.
Product Demand Recovery. (Bullish, Priced In) Global oil demand has mostly recovered from the pandemic lows, and consumption has continued to rise each week. Vaccination rollouts in the U.S. and around the globe continue to gain traction, which has muted the government response to increasing cases from new variants. The EIA forecasts that global consumption, by the end of 2022, will catch and surpass the previous high of 101.35 MMBbl/d set back in 2019. Gasoline and diesel consumption are already back at pre-pandemic levels; jet fuel demand has been a laggard thus far.
USD. (Bearish, Priced In) The U.S. dollar's value has increased substantially since September, though it has retreated since the start of 2022. Fed Chairman Jerome Powell provided hawkish guidance that the Fed will soon begin winding down the emergency economic stimulus program and announced U.S. Federal Reserve raised rates by 75 basis points and signaled further significant rate hikes ahead. A hawkish stance will likely support a stronger dollar and pressure crude prices.
U.S. Production. (Bearish, Surprise) So far, operating-rig data show U.S. private producers have responded to the increase in prices. However, many analysts say that significant U.S. production growth is unlikely without the help of public companies. The drastic increase in the oil price might test the public producers to change their strategy. The shift of E&P's focus from growth to debt reduction has caused CapEx to decline significantly, which has led to a slow recovery in drilling rigs deployed for public companies. Further, the depletion of economic DUCs, means that rigs are an even more meaningful indicator of future production.
Non-OPEC Production. (Bearish, Surprise) Many prominent research groups (EIA, IEA, OPEC) think non-OPEC production, dominated by the U.S., will increase in 2022. If these forecasts come to fruition, it would have a slightly bearish impact on oil prices if the market were otherwise well-supplied.
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