While traders and investors in the paper oil market are focused on looming recessions and interest rate hikes, those on the ground – executives at oil producers and commodity traders – warn of oil price spikes in the future as years of underinvestment have depleted capacity and the potential of new oil production to fill the growing supply gap.
Recession Fears Drag Oil $40 A Barrel Down From Spring Peak
Growing fears of imminent recessions in Europe and possibly in the United States have dominated the sentiment in the oil market over the past three months. Since June, when the Fed started aggressively hiking key funds rates, oil prices have lost around $40 per barrel, slumping below $90 a barrel from $130 in the spring. The zero-Covid policy in China with snap lockdowns and mass mobility restrictions, coupled with concerns about the slowing growth in the Chinese economy, have also weighed on market sentiment.
Many oil futures traders flew the volatile oil market this summer, which reduced liquidity and made any price moves even more volatile. Those who have stayed seem focused on one bearish factor only—recession and the possible hit to oil demand.
However, demand is still holding up, including more demand for oil for switching from natural gas, whose sky-high prices have become prohibitive for many industries and power-generating units in Europe.
The paper market implies underwhelming demand going forward.
However, executives with knowledge of the physical oil supply, trade, and flows say that it would be supply that will struggle to catch up with demand once China’s economy rebounds, and possibly up to 2 million barrels per day (bpd) of Russian crude oil and products have to find new homes outside the EU and the G7 as early as December.
Saad Rahim, Chief Economist for Trafigura, said at the APPEC petroleum conference in Singapore earlier this week that slowing economies and interest rate hikes are set to keep investors and traders off risk assets such as crude oil, which could mean that oil prices may not exceed $100 per barrel again this year. Next year, oil prices could rebound to above $100 if China lifts Covid-related mobility restrictions and the Fed slows or pauses rate hikes to try to boost growth, the economist told Reuters on the sidelines of the event.
“A World Of Commodity Spikes”
Looking beyond Q4 2022, however, the oil market is set for a supply crunch and oil price spikes, according to Trafigura’s Rahim.
The key reason is not Russia and the looming EU embargo and price cap on Russian oil. It’s years of underinvestment in the industry which has deprived major producers of the ability to meet supply shocks of the magnitude at which Russian oil and products could come off the market.
“We’re potentially moving from a world of commodity cycles to a world of commodity spikes because of the under-investment that has taken place in the last decade,” Rahim said at the APPEC conference.
If the world needs to find an additional 2-3 million bpd of oil due to increased demand in China or the U.S. next year, producers would struggle to find those supplies, Trafigura’s chief economist added.
The world’s biggest oil company and largest crude oil exporter, Saudi Aramco, has also recently reiterated the warning it has been sounding for years: a supply shock and wiped out spare capacity are coming when economies rebound.
The ongoing energy crisis, while intensified by the Russian invasion of Ukraine, didn’t start with the war, according to Aramco’s top executive. Years of underinvestment, a lack of a backup plan, and alternatives not ready to step up and replace conventional energy are the real causes of this state of energy insecurity today, Aramco’s CEO Amin Nasser said last week.
Investment in oil and gas more than halved between 2014 and 2021, Nasser said, adding that “The increases this year are too little, too late, too short-term.”
Trafigura’s Rahim said at APPEC, “My view is that people who were not investing at $100 to $120 a barrel this year aren’t going to be investing when it’s $70 to $90.”
Commenting on the tussle between macro and micro factors, Rahim told CNBC Asia: “What we have across commodity markets really is what I would say is the movable object of the tightening micro fundamentals across many of these markets are running up against the irresistible force of these macro headwinds.”
Oil prices may struggle in the short term, but once economies rebound, the world will find itself short of supply of oil and other commodities, Trafigura’s chief economist said.
“We can very well see a situation where next year or whenever we do get out of the slowdown phase... where we find ourselves with extraordinarily low level of inventories already across things like diesel, for example, copper and zinc. And the world needs these materials.”
By Tsvetana Paraskova for Oilprice.com
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