Supply concerns remain the wild card supporting energy prices
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Strongly supported by supply tightness and geopolitical developments caused by changing dynamics, Brent Crude oil remained above $90 per barrel.
Even though the number of confirmed coronavirus disease (COVID-19) cases continues to rise globally, the omicron variant appears to be waning in many parts of the world, encouraging countries to relax restrictions and supporting demand.
Backwardation continues to be the merit of the market, encouraging continued drawdown from stocks.
Investors seem to be focusing lately on recent oil supply developments, speculating that global supply will struggle to meet demand, which was reflected in a surge of oil futures time spreads.
The rally reflects ongoing worries about supply disruptions in some major oil-producing regions. These are driven by the combination of signs of oil demand strengthening, declining oil stocks from the Organization for Economic Cooperation and Development and worries about oil supply disruptions amid political tensions in some major oil-producing countries.
Oil demand rose strongly at the end of 2021. According to energy consultancy FGE, global oil demand in both November and December 2021 was roughly on par with 2019 levels.
The International Energy Agency reported that OECD inventories plunged by 60 million barrels in December, dropping to their lowest level in seven years. The IEA’s report highlighted how market tightness has pushed benchmark crude prices to over $90 per barrel.
The IEA also sees the market returning to surplus in 2022, led by big non-OPEC production increases. IEA estimates spare OPEC+ output capacity at 2.5 million barrels per day, almost all of it held by Saudi Arabia.
An escalation of military tensions between Russia and Ukraine is considered a bullish factor, which increases concerns and volatility, further strengthening prices.
This could also put gas imports to Europe at risk. Of the 155 billion cubic meters of piped gas Europe imported from Russia in 2021, 40 billion were piped through Ukraine. If Russian exports were shut off entirely, Europe would struggle to meet its gas needs. Gas stocks are at five-year lows; international liquefied natural gas prices are highly volatile.
Some of the bearish factors include the potential reintroduction of Iranian crude and the de-escalation of military tensions in Europe. Some industry experts expect Iran’s oil output could be raised to 3.5-3.8 million barrels per day within six months, from almost 2.5 million barrels per day now.
Risks associated with uncertainty will play an additional role in market dynamics. Will the timing for a full recovery of global aviation demand be this year or next year? Chinese demand is another wildcard, which is still weaker than pre-pandemic trends.
With inflation having also been driving commodity prices in the short term, the expected fiscal tightening in the coming months poses a downside risk to gross domestic product growth. In a bearish scenario, prices could fall back to $70 per barrel.
With world oil demand looking most likely to be insensitive to higher prices, prices are likely to move higher until demand may start to be negatively impacted, supply increases, or geopolitical tensions ease.
Short-cycle US shale may surprise on the upside as prices rise beyond expectation. US shale explorers are poised to boost spending by almost 40 percent this year. The US Energy Information Administration expects output to average 12.6 million barrels per day in 2023.
So, if more oil from the US or Iran appears, then it will be skewed toward the second half of the year, putting pressure on prices and easing supplies in the market.
In sum, rising oil prices and tight balances are reviving speculation that OPEC+ may accelerate supply increases and erode demand, which eventually means higher prices cannot be sustained.
• Mohammed Al-Shatti is a Kuwaiti oil analyst.
