Was the oil market panic last week justified?
Ahead of Thursday’s OPEC+ conference, it is evident that delegates are assessing data sets about global oil demand and the state of the world’s economic recovery. At the center of these analyses are potential implications of the latest COVID-19 variant and the US-orchestrated emergency oil inventory releases. Last week’s panicky sell-off in crude oil prices (actually in the broad financial markets) reflected angst about the former.
Regarding the omicron mutation, it seems compelling to note that the countries comprising Africa’s southern tip from which travel has now been restricted account for less than 1 percent of the world’s oil consumption and we would guess they account for a similarly small amount of the world’s economic activity — the two tend to be related. While market sell-offs are not atypical when uncertainty spikes, the above considerations suggest Brent crude oil closing the week at $72 per barrel implies an oil inventory level will be 100 million barrels above our recent estimate. Based on a proprietary model we house, the “fair value” for Brent crude currently is $87 or about $15 per barrel higher than last week’s settlement price.
If you are wondering how to square a 100 million barrel inventory build, it appears the market must have been concerned about one (or perhaps both) of the following. The first would be global oil demand retrenching by more than 3 million barrels per day in the next month. While one could make the case this is possible, it is to us highly unlikely. Global demand would have to experience a month-over-month drop that exceeds the March 2020 fall-off. With the world’s current vaccination rate for COVID-19 now standing near the 50 percent mark, the system appears more resistant to pressures for massive lockdowns and isolating measures that globally impact economic activity.
The second consideration about discounting a 100 million barrel inventory build would be to presuppose that OPEC+ changes its policy and decides to “push” unneeded supply into the market. Such a strategy could lead to inventories building sharply, but such a scenario is also highly unlikely. The group has been consistent about controlling its production in order to whittle down inventories — they have been remarkably successful, as global stocks have been drawn down by more than 480 million barrels since July 2020. Even so, a “pause” in groups quota unwind is a distinct possibility should it sense oil demand is being adversely impacted.
It is notable that the term price structure of Brent (also known as the time spread) did not collapse last week as panic enveloped the oil market (and prices did not flip into a contango structure). The pattern suggests that we are not alone in thinking Friday’s oil market sell-off was an over-reaction.
• Michael Rothman is the president & founder of Cornerstone Analytics, a US-based consultancy focusing on macro-energy research. He has nearly 40 years of experience covering the global energy markets and has been attending OPEC meetings since 1986. He is also the author of “Cornerstones of Life” which is available on Amazon.