Discussion on the future price of oil seems to be a very contentious topic these days. The die-hard bulls will focus on the horrid energy policy failure to enact a path to slowly transition toward clean energy and a gradual release of fossil fuel dependency. This suggests prices remain high for years to come. This secular thesis is based on the lack of investment from major oil companies over the past half-decade, which has made the supply-side tight. But a key variable in this analysis has and will always continue to be demand.
Story Credit: The Street.com, by MALEEHA BENGALI
Demand is something that is not easy to predict or forecast. Demand also changes. The bulls who quote prices of $150 a barrel or higher use a demand figure from last year, which was supported by extreme Covid-induced stimulus that caused a demand surge in a short period of time. But who is to say this demand will be the same forever?
Therein lies the true analysis: As we change cycles, moving from a goldilocks deflationary world to one of stagflation or even recession, this demand side is the outlier. It’s a metric that is never really adjusted for until after the fact. The U.S. products market had been very tight this past winter and distillate supplies had been low. The war on Ukraine exacerbated that product tightness as oil flows had to be rerouted and products were limited in and out of certain states. Also, the type of oil that is used in certain refineries differs as some need heavy and some light. More important, when Brent oil touched $135 a barrel as shorts scrambled to cover their positions expecting the market to lose all the three to five million barrels of Russian oil, the market is slowly waking up to the fact that Russian barrels are not lost, they are just rerouted to other parts of the world that are happy to buy it at a $35 a barrel discount. But now the demand side is called into question. We reached the “choke” point the day we saw Brent hit $135 and U.S. gasoline prices north of $6 at the pump.
Inflation is averaging close to 10% year-over-year in the U.S. and wage growth is nowhere keeping close to keeping up with the rise in food costs and general spending of an average U.S. household. The U.S. economy was showing signs of slowing down before the war even, the war just made the stagflation cycle worse and the Fed’s job that much harder as they are unable to boost the economy with any more stimulus given how worrying inflation is. But that is just the domestic side. China has now officially extended the lockdown in Shanghai “indefinitely” after a nine-day lockdown, as the nation is fixed on its “zero Covid” policy (thereby hurting demand). This is causing backlogs on the supply side, but the overall economic data is showing signs of slowing down. This was evident in the manufacturing PMI numbers that came out, with the Caixin Service PMI for March came in at 42 vs. the previous 50.2, and expected 49.7. The average daily number of cars on the road is expected to drop 21% year-over-year to reach 39 million or 40 million during the Qingming holiday from April 3 to 5, and the number of planned flights is estimated to drop 55% year-over-year, air travelers at 20% of year-ago levels. Even China’s factory orders have contacted the most in two years. There is a real slowdown and this will eventually feed into the Oil market too. If one were to look at the past four weeks moving average of global product demand, we have been seeing weakness over the past two or three weeks. All this is happening at a time when the U.S. strategic reserve is going to release about a million barrels of oil onto the market a day with OPEC+ also boosting production by 400,000 barrels per day every month.
At the end of the day, commodities are all about the demand vs. supply balance at any given time. If one side exceeds the other, the price moves to a point of equilibrium where the other starts to catch up. Extreme emotions are seen on both sides, but these variables are not constant, just the supply is a lot easier to forecast as it takes years to see investments come through. The demand side caught the market by surprise last year and into Q1 of this year, but that does not mean it will keep growing at the same rate. But alas, once demand falls and prices move down, that is when we shall start to see the downgrades come through — by the same houses that called for $150 to $200 a barrel of oil. But it may be too late. Oil is all about timing, but it is important to distinguish between the cyclical trade and the secular one.