Pack 6 Group, a risk management consultancy in the oil and gas industry, sees global oil prices rebounding back above $85 in the second half of 2023.
In March, the US Energy Information Administration published its Short-Term Energy Outlook in which they projected a decline in global crude oil prices beginning in the second half of 2023, with yearly Brent price averages of $83 and $78 for 2023 and 2024, respectively. [1] The upshot: the EIA sees annual average prices declining because supply of global oil is expected to outpace consumption.
Pack 6 thinks that may not be the case.
Rising Chinese demand and price jumps from supply shocks
Declining macroeconomic inflationary fears
Increasing supply manipulation by OPEC, domestic producers
For starters, energy supply is notoriously susceptible to fluctuations in investor sentiment in the broader marketplace and these can affect prices significantly. Case in point: the current decline in oil price that we are witnessing in the second half of March 2023. This decline is coming from general investor nervousness created by the acute banking crisis brought on by SVB and Credit Suisse. This has led to capital outflows from energy stocks, which in turn will likely lead to deficits and supply constraints in the coming months. On the other side of these constraints, however, is opportunity. Goldman Sachs’ Global Head of Commodities recently opined on the predicted deficit as a key driver of price growth toward the end of the year. [2]
The key takeaway here is that short-term flightiness in the marketplace typically shocks the energy supply curve (by changing capital allocations) without necessarily impacting the demand curve. This leads to short-term price contraction followed by price expansion coming from that supply bottleneck. We saw this in the initial days of the Ukraine war as well as at the start of the pandemic. In fact, according to historical price data, the market downturns in 2001, 2008, and 2020 all demonstrated a global oil price decline of 20-50% in the year of the downturn; however, in each year immediately following the crisis, oil prices rebounded and only 2008 took more than a single year to achieve the pre-crisis price. [3] So it seems that in an unstable macroeconomic environment, short-term price declines are typically followed by longer-term price growth at least partially due to the supply crunches they create.
So what? Pack 6 says in an age of truly global uncertainty – both economic and political – any analysis that doesn’t factor in the effect of these short-term market runs is undervaluing the commodity itself because they are likely to keep occurring. Nonetheless, the EIA’s price predictions could still be correct if their central thesis holds true: will global oil consumption lag behind global supply over the next two years?
Pack 6 points to the growth in Chinese demand for oil as the first reason for why it very well may not.
The Chinese economy is beginning to prop up global oil demand from recent lows as its economy begins the long recovery toward pre-pandemic growth rates. Following the repeal of Xi’s “Zero Covid” policy in December of 2022, increases in Chinese demand have been larger than was previously forecasted by independent bodies, leading both OPEC and the EIA to revise their previous consumption projections in at least two consecutive monthly outlooks. [4]
Importantly, it’s only been 4 months since the repeal of Zero Covid. The Chinese economy has been on standby for nearly three full years. Pack 6 believes that there’s lots of room for this pent-up demand for oil (and everything else) to grow significantly as recovery boosts investment, which in turn boosts consumption. For now though, Chinese demand for oil and other commodities is “surging” and Goldman Sachs points to this as a major indicator for global oil prices closer to $100 in 2024. [5]
At this point, in order for the EIA’s thesis to hold, two assumptions must be true. First, oil consumption outside of China must be declining by at least enough to offset the growing demand within China. Second, oil supply must not adapt to projected fluctuations in demand. Both assumptions appear to be increasingly tenuous.
Take declining global consumption. There is no doubt that global oil demand has fallen in the current macroeconomic environment. A year of rising interest rates tempers demand across the board; however, as various stakeholders continue to upwardly revise their Chinese demand projections, any preexisting mismatch in supply and demand is correspondingly reduced unless demand elsewhere is falling accordingly. With the Fed sticking to their original rate hike schedule and signaling that the “disinflation” process is underway, it seems less likely than it did two months ago that major monetary shocks are going to keep hitting global markets.[6] Even more unlikely is assumption number two: that supply of global oil is mostly independent from demand. It’s not. To see why, just look at OPEC’s behavior in the last few years.
In October of 2022, OPEC cut supply by two million barrels per day. In March of 2023, according to Reuters, “OPEC members are pumping almost 1 million bpd less than their target, according to the group's own figures and other estimates.” [7] Pack 6 points to this more recent action is a literal manifestation of OPEC throttling back on supply while they watch how Chinese demand navigates the macro inflation environment.
The bottom line: OPEC, which controls 40% of global oil supplies, has in recent years proven itself increasingly willing to manipulate global oil supply to support prices and match up with consumption targets. [8]
When will OPEC take action to reverse price depression? It’s hard to say and the short-term dips in price could be painful. Still, Pack 6 believes that this demonstrated willingness to intervene in global oil supply (which is a defining trait of why OPEC exists) is not likely to recede in the face of growing geopolitical uncertainty.
Of course, OPEC is not the only group supplying oil to the global marketplace. For US-based suppliers, the story is less about artificial cutbacks and more about physical and financial limitations.
Pioneer Natural Resources CEO Scott Sheffield told CNBC on March 7th that the growth of oil production in the US will be at a “very slow pace” because the industry simply doesn’t have the requisite refining capacity or inventory to quickly return to pre-pandemic levels of supply.[9] In addition, there has been an increasing reluctance by oil companies to spend their record profits on production increases, instead opting to buy back shares and increase shareholder dividends in recent years. Clearly, even outside of OPEC-produced supply, the rate of growth in oil supply over the next two years is still an open question.
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Taken all together, Pack 6 sees a landscape in which market volatility is creating supply crunches, Chinese demand for oil is bolstering global demand, and key global suppliers are dynamically adjusting supply to prevent price collapses. All of these trends are likely to continue until macroeconomic conditions improve (rates go down) and geopolitical crises resolve (guns go down). This does not appear to be imminent in 2023. As a result, all of these influences put an upward pressure on global oil prices and form the core of Pack 6’s prediction that global prices move back above $85 by the end of this year.
Sources:
[1] U.S. Energy Information Administration. (2023, March 7). Energy Prices – Short-Term Energy Outlook, - March 2023. U.S. Energy Information Administration. https://www.eia.gov/outlooks/steo/tables/pdf/2tab.pdf [2] Payne, J. (2023, March 21). Goldman Sachs expects commodities supercycle. The Globe and Mail. https://www.theglobeandmail.com/investing/investment-ideas/article-goldman-sachs-expects-commodities-supercycle/ [3]Yahoo Finance. (2023, March 23). Crude Oil May 23 (CL=F). Yahoo Finance. https://finance.yahoo.com/quote/CL%3DF/history?period1=969667200&period2=1679529600&interval=1mo&filter=history&frequency=1mo&includeAdjustedClose=true [4] Lawler, A. (2023, March 14). OPEC raises Chinese oil demand growth view, flags econ risks. Reuters. https://www.reuters.com/business/energy/opec-raises-chinese-oil-demand-growth-forecast-further-2023-03-14/#:~:text=OPEC%20expects%20Chinese%20oil%20demand,the%20United%20States%20and%20Europe. [5] Khan, S. (2023, March 23). Oil Drops 1% as US in no rush to refill strategic reserve. Reuters. https://www.reuters.com/business/energy/oil-prices-fall-investors-weigh-fed-chair-comments-rate-hike-2023-03-23/ [6] Henney, M. (2023, February 1). Fed raises interest rates by a quarter point but signals inflation fight's not over. FOXBusiness. https://www.foxbusiness.com/economy/fed-raises-interest-rates-quarter-point-signals-inflation-fights-not-over [7] Lawler, A. (2023, February 10). Analysis: Oil rebound more likely this year, $100 a barrel possible, OPEC sources say. Reuters. https://www.reuters.com/business/energy/oil-rebound-more-likely-this-year-100-barrel-possible-opec-sources-say-2023-02-10/#:~:text=LONDON%2C%20Feb%2010%20(Reuters),return%20to%20%24100%20a%20barrel. [8] Ellerbeck, S. (2022, November 11). Explainer: What is OPEC? World Economic Forum. https://www.weforum.org/agenda/2022/11/oil-opec-energy-price/#:~:text=OPEC%20member%20states%20produce%20about,the%20world's%20proven%20oil%20reserves. [9] Thomas, I. (2023, March 9). U.S. Won’t Reach a New Record in Oil Production “Ever Again,” Says Pioneer Natural Resources CEO. CNBC. https://www.cnbc.com/2023/03/09/us-wont-reach-new-record-oil-production-ever-again-pioneer-ceo.html
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