Thought of the day

Crude oil prices have remained volatile this year, with markets torn between fears of an extended Fed rate-hiking cycle due to a tight US labor market versus optimism over a recovery in oil demand as China’s economy reopens. As a result, Brent crude is trading at a similar level to the start of the year, around USD 85/bbl.

But we believe that the tightening of the oil market this year will eventually put prices on an upward trajectory. Russia’s announcement last Friday of an output cut in March is a reminder of these dynamics.

Russian output set to fall. Although Russia managed to find alternative buyers, primarily in Asia, for its crude after the European Union banned its imports in December, the curb on Russian refined products in February is set to weigh on Russian production, in our view. Indeed, the Russian Deputy Prime Minister Alexander Novak said on Friday the country will cut its oil production by 500,000 barrels per day (bpd) in March.

Despite Novak’s claim that the production cut was aimed at improving the market situation, we believe that the decision was probably due to recent embargoes. We earlier noted that the EU ban on Russian refined products such as diesel from 5 February will likely hurt Russia’s oil production as it will face difficulty in finding sufficient buyers to make up for the loss of European demand. The lack of adequate smaller tankers may also make it more challenging for Russia to divert refined products to other markets. There is also a limit to how much additional crude China and India can absorb, in our view. Therefore, we expect Russian crude production to fall below 9 million barrels per day (mbpd) in 2023 from levels above 10mbpd at the start of 2022 and 9.77mbpd in December.

China's unexpectedly abrupt reopening is giving a lift to global oil demand. We believe two-thirds of growth in oil demand this year will come from emerging Asia, led by China’s reopening—which we think will lift global oil demand to above 103mbpd in the second half of the year. We believe China’s economic recovery will be led by consumption, which we expect to grow 7% this year after contracting 0.5% last year. Mobility data over the Lunar New Year holiday are already showing signs of a sharp pickup in travel with nearly 96 million people making trips on railways, planes, and ships over the four-day period, up from 74.4 million in the same period last year. Although cross-border travel is still around 20% of 2019 levels, we expect it to recover with the recent removal of cross-border travel requirements with Hong Kong and Macau.

Modest supply growth from non-OPEC+ will add to market tightness. We expect non-OPEC+ nations to provide only modest supply growth this year, adding 1.3mbpd primarily from US oil production, but trailing oil demand growth of 1.6mbpd this year. Underinvestment in the exploration and development of new oil supply, capital discipline, and high inflation are also slowing supply expansion among non-OPEC+ producers. As a result, the oil market is set to be dependent on OPEC+, which on Sunday forecast that global oil demand will exceed pre-pandemic levels this year.

So, we maintain our positive outlook on oil as we continue to expect Brent to rise to USD 110/bbl and WTI to USD 107/bbl this year. We reiterate our advice for risk-taking investors to add long exposure via first-generation indexes or longer-dated Brent contracts or to sell Brent’s downside price risks