While crude ended August 2.1% higher, trading has been volatile, with markets oscillating between fears over the strength of China's economy and optimism over the potential of a soft landing for the US economy.
In particular, disappointing July economic and credit data out of China, the world's largest oil importer, triggered fears that a weakening Chinese economy may weigh on global oil demand. On the other hand, falling inflation and a cooling labor market in the US helped boost confidence that the Fed may be at the end of its rate hiking cycle. This, coupled with higher-than-expected declines in US crude stockpiles, helped push oil prices higher.
Although oil prices retreated again on Tuesday, we believe the recent rally has further to run for several reasons:
Global oil demand is reaching record highs and is set to expand further. According to the International Energy Agency (IEA), robust summer air travel coupled with increased use of oil in power generation has pushed global oil consumption to an all-time peak. Oil demand hit 103 million barrels per day in June, and is set to rise further in August. Despite the recent weak economic signals, China’s demand hit fresh highs amid surging petrochemical activity. Overall, the IEA estimates oil demand to grow to around 102.2mbpd for the year, its highest ever annual level, with China accounting for over 70% of the increase.
OPEC+ production cuts are set to keep oil supply tight. Voluntary OPEC+ cuts led by Saudi Arabia have kept oil markets undersupplied for the past four months. Global oil supply plunged by 910 thousand barrels per day to 100.9 mbpd in July, led by the huge reduction in Saudi’s crude production. Saudi crude exports have reached a 28-month low, and the nation is widely expected to extend its voluntary 1 mbpd supply cut into October. Meanwhile, in the past week, Russia's deputy prime minister also signaled a new OPEC agreement to reduce Russia's oil exports. With Saudi Arabia's and Russia’s extended production curbs, we expect global oil markets to be undersupplied by around 2mbpd in August and by over 1.5 mbpd in September.
Declining inventories are supportive for oil prices. Globally recorded oil inventories fell by 17.3 million barrels in June, led by declines in OECD stocks, and preliminary data indicates a further draw in July and August, according to the IEA. Within the US, crude stockpiles have also seen faster than expected draws, indicating the overall challenge to keep pace with rising demand. Asian and European oil refineries are increasingly obliged to find alternative barrels from non-OPEC+ producers amid supply cuts from the OPEC+ bloc. The IEA estimates that oil inventories could decline by 2.2 mbpd in the third quarter of 2023 and 1.2 mbpd in the fourth quarter, if OPEC+ maintains is current production targets, and this may drive oil prices even higher.
So, while oil prices have rallied recently, oil markets look likely to remain in deficit for the upcoming months, and we still see scope for crude oil prices to rise further. We retain a most preferred view on oil in our global strategy and forecast Brent at USD 95/bbl and the US WTI benchmark at USD 91/bbl by end-December. We also like US energy equities, with the latter expected to catch up with the broader markets as investors reconsider the earnings read-through and undemanding valuations.
Main contributors - Solita Marcelli, Mark Haefele, Giovanni Staunovo, William Choo, Vincent Heaney
Original report - Oil prices reach yearly highs amid solid fundamentals, 5 September 2023.