Energy, Commodities Crude oil: Fasten your seatbelt

Both Brent and WTI increased by about USD 10/bbl in the last four weeks, with prices now trading at their highest level since mid-April.

Support from the “Saudi lollipop”

From a fundamental perspective, the recent price uptick has been driven primarily by OPEC+’s voluntary production cuts announced in April and implemented in May. Some recent unplanned production outages during the demand-heavy Northern Hemisphere summer months also helped. And in the months ahead, oil markets should tighten further as Saudi’s extra voluntary 1mbpd production cut for July and August—described by the Saudi energy minister as the “Saudi lollipop”—comes into effect. With demand growing at a solid pace, the ongoing removal of barrels is gradually pushing oil prices up.

Oil demand growth is solid, but heterogenous

Despite the recession concerns, oil demand remains solid at above 102mn barrels per day (mbpd) and set to breach 103mbpd in August for the first time. But the numbers belie a fragmented picture. Demand in OECD is lackluster, mostly driven by weakness in Europe, and demand in OECD Americas and OECD Asia Oceania is uninspiring. Demand growth continues to be driven by emerging Asia, with China and India accounting for most of it, while demand from Brazil and the Middle East has been solid as well. Looking at refined products, manufacturing weakness has translated into weak diesel demand, with growth driven by jet fuel and gasoline, indicating a still-strong desire to travel.

Some temporary production outages have also helped tighten up the oil market: A fire at an oil platform in Mexico, power outages and unscheduled maintenance in Kazakhstan, an oil spill at an export terminal in Nigeria, and protesters stopping production in Libya. Libya remains a wildcard, with some political stakeholders threatening to stop production in September if their requests are not met.

OPEC+ exports at a 22-month low

OPEC+ production has dropped since the April decision to remove barrels from the market from May; the group’s crude output hit a one-year low in June. Production in July is likely to be considerably lower due to Saudi’s extra voluntary cut and the above-mentioned production outages. Data on oil exports indicates OPEC crude exports sank by more than 1.1mbpd in the first 23 days of July versus June levels, and exports by OPEC+ allies fell by more than 0.6mbpd in the first 21 days of July versus June, driven by lower crude exports from Russia (down by almost 0.5mbpd), according to Petro-Logistics. Full-month exports for July may be down a bit less after Libya’s production has recovered following the end of the protests.

Lower exports have started dragging down oil-on-water inventories, which consist of oil transiting on tankers and oil held in floating storage. Moreover, as a result of the extra Saudi production cut and the higher official selling prices of Saudi barrels, refineries in the Atlantic basin are looking for alternative barrels in the North Sea and North and South America. Also, the decline in Russian crude exports should continue in August, which should also help tighten the oil market.

Retaining a positive price outlook

We project a market deficit of 0.7mbpd in June and around 2mbpd in July and August. We expect oil prices to trend even higher once these deficits become visible in on-land oil inventories. The size of the market deficit in September will depend, among other factors, on if the extra 1mbpd Saudi production cut is extended into September. We expect to hear more about the Kingdom’s plans in the first week of August. Back in 2021, the 1mbpd voluntary production cut stayed in place for three months, followed by a 0.5mbpd cut in the fourth month. Should the 1mbpd voluntary Saudi cut be extended, that would likely see another deficit in September of more than 1.5mbpd; if halved, that deficit would still be more than 1mbpd.

If this outlook is correct, on-land oil inventories should fall over the coming weeks. On-land oil inventories have not yet started to drop on a sustained basis; a drop has only been visible in on-water inventories. We expect both on-land and on-water inventories to show declines in the weeks and months ahead. Hence, we retain a positive outlook for oil prices—we expect Brent to move into a USD 85–90/bbl range and WTI in a USD 80-85/bbl range over the rest of 2023. We therefore continue to advise risk-taking investors to add long exposure via first-generation indexes or longer-dated Brent contracts, or to sell Brent's downside price risks.

Authors: Giovanni Staunovo, Wayne Gordon, Dominic Schnider

Original report - Crude oil: Fasten your seatbelt , 27 July, 2023.