It’s been a wild week for oil prices. First soaring on news of the biggest U.S. inventory draw in years, benchmarks later slumped just as sharply when Fitch downgraded the United States’ credit rating from AAA to AA+.
Barely a day later, prices rebounded again after Saudi Arabia did what pretty much everyone expected, extending its voluntary production cuts of 1 million barrels daily into September. Where prices go from here is anyone’s guess, but analysts are saying the rally won’t last.
That appears to be the opinion of the majority of analysts polled recently by the Wall Street Journal. Per that poll, Brent crude should average $87 per barrel in the current quarter and remain around this level until the second quarter of 2024.
For West Texas Intermediate, the analysts see a price of $83 per barrel this quarter and into the first half of 2024. Even with continuing cuts from OPEC+ and a rebounding Chinese economy.
The reason they don’t see prices much higher is that China’s recovery from the pandemic is moving more slowly than expected and, interestingly, that Saudi Arabia’s voluntary cuts have increased its spare production capacity.
China has indeed been recovering more unevenly than analysts seem to have pictured it, but it is recovering, and its oil demand is at a record high. It may, however, have peaked earlier in the year, which would suggest slower growth in the next five months and possibly beyond. Related: Bullish Momentum Is Building For Crude
As for spare production capacity, that was a substantial concern a couple of years ago when demand for oil began to recover after the first wave of lockdowns. The concern was that, because of underinvestment, the global oil industry had not enough spare capacity to respond to a potential surge in demand.
For now, this warning has not had to be tested, but Saudi Arabia is working on expanding its spare capacity over the medium term. While it does that, however, it is also limiting production. By limiting production, it is limiting the amount of oil immediately available to buyers, which renders the argument for greater spare capacity a little irrelevant.
Saudi Arabia may boost its total production capacity to 13 million barrels daily, as it plans to do, but if it is only producing 9 million barrels daily to keep prices above $80, the size of its spare capacity has very little importance for day-to-day and even longer-term price developments.
There is one more factor that is acting as a cap on prices, however, and that is the rebound in offshore drilling. Wood Mackenzie reported last month that deepwater rig utilization is on the rise as companies step up exploration offshore. Goldman Sachs also noted this rebound in a recent note, cited by the WSJ.
“The significant rise in OPEC spare capacity over the past year, the return to growth in international offshore projects, and declining U.S. oil production costs limit the upside to prices,” the bank said.
It’s worth noting that along with falling oil production costs in the U.S., production growth is also slowing down, which should boost the upside to prices. The EIA recently projected that shale oil production is set to decline this month after hitting a peak in July. The August decline, to 9.4 million bpd, will be led by the Permian, the most productive shale basin right now.
Meanwhile, Saudi Arabia has indicated it may extend the cuts further or deepen them. Saudi Arabia appears back into “Whatever it takes” mode to keep prices at levels that are closer to its government spending plans. And there is little any other producer can do to counter the effect of those cuts in short order.
The main drag on prices remains the economic outlook for the biggest consumers. Until recently, the fear of a recession in the U.S. held sway over traders, but recently the outlook brightened, which contributed to higher prices.
Then came the Fitch downgrade and although Treasury Secretary Janet Yellen said it was “entirely unwarranted” and JP Morgan’s Jamie Dimon called it “ridiculous”, the downgrade rattled markets.
In fact, Dimon said that the U.S. economy is doing so well that even if a recession does emerge, it will not be that big of a deal.
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“It’s pretty good, even if we go into recession,” Dimon said, as quoted by CNBC, this week. “The storm cloud part is still there.”
It is this storm cloud, along with economic trends in Europe and Asia that will continue to shape oil prices over the coming months. Grave recession warnings have yet to materialize, if ever, and that fact has served to moderate the rise of oil prices. But if Saudi Arabia decides to deepen the cuts and Russia plays along with its own curbs, the current factors that cap oil prices may weaken enough to allow a stronger rally.
By Irina Slav for Oilprice.com
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