Shortage of supply pushing oil prices higher
Last week, oil prices continued their rallies, as demand looks strong with the starting of the US driving season and the gradual reopening in China after two months of strict lockdowns in Shanghai. The prices also rose due to the worsening global oil supply picture.
On Thursday, when writing this piece, Brent crude broke the resistance level of $115 a barrel and was trading at $117.6 a barrel, and West Texas Intermediate prices at $114.3 a barrel. Further deterioration in the supply situation and strengthening oil demand may open the door for Brent to break the next resistance level of $120 a barrel.
Brent and WTI moved in different directions, as a result, the spread became even wider. WTI lagged amid news that the US could impose export restrictions to lower domestic fuel prices.
In this regard, the head of the US Department of Energy said that the president does not rule out the introduction of export restrictions to limit the growth of domestic fuel prices. Given the current situation, this cannot be called unexpected, since fuel prices in the country are at record highs.
Indeed, a partial reduction in export volume could significantly support local consumers. However, these barrels will leave the global market, so the overall balance in the world will remain the same. This is an argument in favor of maintaining high prices against the background of further widening the spread between Brent and WTI to equilibrium values around $4 a barrel.
Observations of tracking activity on the roads show that record gasoline prices do not destroy demand and US citizens actively get behind the wheel. This suggests that the situation with the availability of fuel in June may worsen. The US administration is actively looking for ways to stabilize the situation. In April, sales from strategic petroleum reserves began, which in six months could reach a record of 180 million barrels. In May, it was reported that President Biden was considering the possibility of releasing an emergency diesel stock on the market for the first time since 2012.
Indeed, the fuel situation in the US is very tight on the eve of the driving season. At the same time, seaborne supplies from Russia look weak, as the EU threatens to impose sanctions on Russian oil.
According to Russian Deputy Prime Minister Alexander Novak "crude oil production in Russia could shrink by up to 8 percent this year.” As of mid-May, Russia’s oil production was 830,000 barrels per day lower than it was in February. This means that Russia’s current production is below 10 million bpd, at around 9.16 million bpd, according to the Bloomberg calculations, and more than 1 million bpd below its quota under the OPEC+ deal.
It is not yet clear whether it will be possible to agree on sanctions on Russian oil, but even in the event of another failure, the policy of abandoning Russian oil will be implemented at the national level. The largest buyers of Russian oil in the EU, Austria, and Germany, have already stated that in any case, they will try to reduce purchases to zero by the end of 2022.
Russia supplies about 4.5 million bpd of liquid hydrocarbons to Europe. The question is how realistic it is to abandon such a volume before the end of the year. Even if it is too expensive, political support for such decisions is high — European countries are probably willing to pay for it with a longer period of high prices. Therefore, the political situation in the European direction continues to be conducive to upward pressure on oil prices.
It seems that OPEC+ does not succumb to persuasion and does not intend to increase production, as this will strengthen the future supply surplus in the market. It is widely expected now that the group in its upcoming meeting on June 2 will keep its monthly production increase at 432,000 bpd for July. OPEC+ is estimated to be more than 2 million bpd below quota.
Referring to a new crude production deal, Saudi Energy Minister Prince Abdulaziz bin Salman told the Financial Times in an interview that “he sees Russia as an integral part of the OPEC+ group of oil producers, adding that politics should be kept out of the alliance.” He blamed soaring gasoline prices on taxes and a lack of global refining capacity.
EIA’s supportive weekly inventory report also added to last week's price rallies. Commercial crude oil inventories fell by one million barrels in the week to May 20. At 419.8 million barrels, crude oil inventories are 14 percent below the five-year average for this time of the year. Total motor gasoline inventories decreased by 500,000 barrels last week and are about 8 percent below the five-year average for this time of year. US gasoline stocks are likely to remain tight as demand picks up over the driving season.
The only restraining factor for prices is the lockdown in China. Restrictive measures in Shanghai continue to weaken, but the situation in Beijing is deteriorating. As part of China’s zero-COVID-19 policy, the authorities are tightening restrictions. The capital is comparable to Shanghai in terms of population and level of economic activity, so the easing of the lockdown in Shanghai is offset by tightening in Beijing. The situation is increasingly conducive to the fact that the suppressed demand for fuel in China may stretch into June, which may limit the potential for price increases.
Against this background, oil prices will continue their gradual upward movement, and if they manage to gain a foothold above $115 a barrel, they can soon start to break into the $120 mark for Brent.
• Dr. Namat Al-Soof is an Iraqi oil expert with long experience in upstream and market analysis. He held senior analyst positions at OPEC, IEF in Riyadh, and OPEC FUND for International Development. Currently, he is a consultant to a number of companies in the oil industry.