Commodity analysts have been on a forecasting binge recently as oil prices climb higher amid surprisingly strong demand and unsurprisingly short supply. Most believe oil has a lot higher to go. Others have reason to doubt that. One of the “dissenters” is Citi’s Ed Morse, who earlier this week told Bloomberg that while prices will continue to rise this quarter, next year the U.S. could surprise everyone with its production growth, suggesting that we might see an end to the oil rally as more supply comes online.
Another of those not sharing the strong bullish view is Mohamed El-Erian, the chief economic adviser of Allianz and chair of Gramercy Fund Management. This week, El-Erian cautioned against too much optimism in oil prices because the higher oil prices went, the greater the pressure would be on oil demand.
Speaking to CNBC, the expert noted that the current situation is a result of two unforeseen circumstances. On the one hand, El-Erian said, nobody had expected demand to rebound so quickly and so strongly. On the other, nobody had expected the energy crunch and the challenges in the energy transition.
Calling these two unthinkable just a year ago, El-Erian essentially highlighted how limited the horizon of most oil price forecasters is. A limited horizon, in turn, makes for quite imperfect predictions. Indeed, 18 months ago, the very thought of oil rebounding to $80 per barrel must have seemed far-fetched even to some Big Oil CEOs. Now, there’s talk about Brent hitting $100 or more.
This is unlikely to happen, according to El-Erian, for a very simple reason: the higher the price, the more reluctant people will be to buy a commodity. This is perhaps one of the simplest market principles, and it is the principle that drives the cycles of commodity industries.
“If you were to focus only on the supply side, you could get to oil at $100, because there has been underinvestment in the industry in general, and demand will stay robust,” he explained. “But if you look at what is happening on the demand side, there you get some questions. Demand is robust today but will it be robust in six months’ time? There are some really big questions in terms of demand destruction — people buying less because prices are higher — and in terms of whether policy becomes contractionary or not.”
Uncertainty about demand is what OPEC says makes it stick to its original production increase agreement despite increasingly frantic calls for more supply from large consumers such as the United States. The cartel made a special note of this in its latest Monthly Oil Market Report.
In it, OPEC revised its oil demand growth forecast for this year down by 160,000 bpd to a total of 5.7 million bpd. For this quarter, OPEC cut its oil demand growth by a lot more—330,000 bpd—saying “a slowdown in the pace of recovery in 4Q21 is now assumed due to elevated energy prices.” In other words, the energy crunch that first benefited oil prices is now apparently hurting demand for the commodity.
Yet, the price-driven pressure on oil demand is only one side of the coin. The other is supply and energy—rather than oil—demand. In his interview with CNBC, El-Erian noted that the energy crunch was related to the fact that alternatives to fossil fuels were not “amply available”. Meanwhile, IHS Markit’s Daniel Yergin has warned that markets could see a series of crunches because supply will continue to fall short of demand.
Yergin noted what he calls a disconnect between the dynamics of oil markets and energy policies being implemented, CNBC reported, citing the oil expert. It is perhaps this disconnect that would lend additional upward pressure to oil prices, countering the natural downward pressure that excessive prices normally have on oil demand.
By Irina Slav for Oilprice.com
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