Are oil prices set for a rally?
More than a million barrels daily in additional production cuts from OPEC+. Record crude oil imports from China. A bullish outlook for air travel, hence jet fuel demand, this year. Yet nothing seems to be able to move oil prices much higher than where they are stuck right now – between $70 and $75 per barrel.
The bearish factors are clear and, indeed, significant: uncertainty about the pace of China’s economic rebound from the pandemic, despite the record rate of oil imports; and inflation and recession fears that seem to have become epidemic in incidence among commodity traders.
There is also a third bearish factor at play—a new factor that was not around in previous industry cycles. That’s the energy transition and the dozens of forecasts saying that the shift to wind, solar, and EVs will kill oil demand.
The latest in that bunch of forecasts came from the Canada Energy Regulator, no less. The CER used computer modeling to predict oil demand over the long term and found that a successful transition to a net-zero state of the global energy system would reduce oil demand by 65% by 2050.
That’s quite a significant reduction, even if it’s not a complete “death” of demand. Meanwhile, however, the International Energy Agency said this month it expected oil demand growth to peak before 2030, again because of the transition.
“The shift to a clean energy economy is picking up pace, with a peak in global oil demand in sight before the end of this decade as electric vehicles, energy efficiency and other technologies advance,” IEA chief Fatih Birol said. “Oil producers need to pay careful attention to the gathering pace of change and calibrate their investment decisions to ensure an orderly transition.”
With such a degree of certainty coming from organizations such as the IEA and the CER, many producers would indeed think twice about their growth plans. And this is what brings us to the greatest risk of the current situation with oil prices: a surge down the road, resulting from the market swinging into a deficit.
This is not a new scenario. In fact, analysts have been warning about it for a while. According to recent data from Rystad Energy, that deficit could reach 2.4 million bpd over the second half of the year. Demand, meanwhile, will grow by 1.7 million bpd. Where exactly can oil prices reasonably go in such a context? Up.
And they will go up as soon as traders discover the gap between supply and demand, and recall the fact that oil demand is quite inelastic because of the fundamental nature of the commodity. Oil is used in pretty much everything in one form or another. This means that whatever the price, demand will change little.
For now, traders seem preoccupied with China’s return to normal, Europe’s recession and U.S. inflation, and seem to have forgotten that last fact. But at the same time, they are seeing stable oil exports from Russia despite its pledge to cut output by half a million barrels daily, higher oil exports from Iran, and lower-than-planned output cuts from OPEC+.
There is, in other words, plenty of supply at the moment, as far as traders are concerned. And demand doesn’t seem like it will be picking up strongly anywhere anytime soon, at least based on mobility data.
Global road traffic, Rystad reports, has recently fallen below 2019 levels in the past couple of weeks. Yet for the three months before that, it was above those levels.
But here’s an interesting report from the IEA from last year. In mid-June 2022, the IEA predicted that the supply of crude oil would have to catch up with demand this year.
“Global oil supply may struggle to keep pace with demand next year, as tighter sanctions force Russia to shut in more wells and a number of producers bump up against capacity constraints,” the IEA said in its June 2022 market report.
We all saw how that turned out, and Russian exports are becoming something of a mystery because, Rystad again notes, Russia has indeed cut production—by about 400,000 bpd. This is lower than promised, but it’s not a little. Yet exports remain stronger than virtually everyone expected them to be.
This, and the apparently unsatisfactory pace of China’s economic growth, are the two factors keeping supply concerns in check. For now. Because sooner or later, the additional OPEC+ cuts will begin to be felt. There is a simple reason for that: demand will not be falling to any degree proportional to supply cuts.
All this means that oil bulls could yet have their day later this year, especially as the northern hemisphere moves closer to winter and heating demand pushes oil demand higher. Summer driving season may be a good indicator of oil demand trends, but winter heating season is better. Traveling in the summer is a question of preference and means. Staying warm in the winter is a necessity.
