The inventory versus geopolitical game in oil markets

At this early stage in the first quarter of 2022, the oil market outlook remains tight and prices are still recording high levels despite the general agreement that surplus will eventually develop.
Crude oil prices remained firm, registering levels not seen in more than seven years as investors are focusing on rising geopolitical tensions in major oil-producing regions that could exacerbate the outlook for oil supply.
Disruptions in oil productions resulting from unplanned outages in Libya, Ecuador and Kazakhstan, and downgrades to US, Russia and Brazil forecasts could also lead to a decrease in supply by 1 million barrels per day.
Investors are also likely looking beyond the omicron variant, betting on a stronger global oil demand recovery in the upcoming months amid signs of strong fundamentals in the physical market.
On top of the tighter supply market, the geopolitical standoff between the US and Russia risks a gas war and would spur incremental demand for heating oil.
The targeting of oil facilities in the UAE raises the question of even more supply disruptions in the region this year. This may add to geopolitical risk in the region and may signal the Iran-US nuclear deal is off the table for the near future.
Globally, prices experienced high volatility due to news of pipeline disruptions emerging from Iraq. The Iraq-Turkey pipeline carries a mix of Basrah and Kirkuk grades with a capacity of 450,000 barrels per day.
Brent, WTI implied volatility term structures indicate higher downside risk is being priced in the coming months, with the most recent up leg creating a bit of an air pocket in which prices could correct.
OPEC expects global oil markets to remain well supported in 2022 by robust demand, maintaining the confident outlook that has allowed the continuation of the increase in production strategy, which started since August 2021. The market’s strength is likely to persist even as central banks tighten monetary policy.
China crude imports rose to 10.9 million barrels per day in December as independent refineries increased deliveries to fully 
utilize their import quotas by year-end. Rongsheng continued to clear its backlog of cargoes that were floating around Chinese waters. China’s crude imports are estimated 
to remain flat in January, before falling gradually to 10.5 million barrels per day levels in March.
Overall, crude output from US major shale formations will rise to 8.54 million barrels per day in February, the highest since March 2020.
Gas market sentiment is cautiously bearish this week, driven by tepid demand in Asia and robust LNG imports into Europe. But a bullish overhang persists that could limit the downside to prices.
The Germany-Poland section of the Yamal Pipeline has operated in reverse mode for nearly a month, indicating participants’ preference to use up gas from storage and potentially restock once prices decline.
Tensions between Russia and Ukraine, and the impact on the Nord Stream 2 regulatory process are mitigating downside risk and will continue to be a bullish factor through most of this year, as many believe the pipeline is Europe’s only shot at a boost in export volumes from Russia.
Relative to 2021, an incremental volume of up to 30 billion cubic meters of gas may be available from Russia to Europe, with risk of almost none of that materializing if tensions between Russia and Ukraine escalate to military conflict, a scenario that would also likely disrupt existing flows.
While physical markets are showing signs of tighter supply, global oil stocks 
have started to build since mid-December. Our fundamentals outlook is for a continued modest stock buildup for the next few months, followed by tighter balances in the second half of 2022. Risks are skewed with a more potential downside to supply than upside.
Oil prices will eventually run out of momentum and likely come down rapidly near term with building of stocks being one driver to watch closely.
The general price trend should reflect fundamental easing in Q1 followed by tightening by mid-year, but this will likely be offset by supported demand from the financial markets.•

• Mohammed Al-Shatti is a Kuwaiti oil analyst.