Oil’s Path Upward
July 7, 2023
OPEC+ supply cuts and a failed weekend Russian coup has brought oil front and center, albeit without any meaningful price impact. After a monumental 60% run in 1H 2022, oil fell drastically off its peak (~40%) and is down 10% in 2023. Drivers are plentiful: upward surprise in Russian output, OPEC+ supply constraint actions and waning demand in the face of hawkish central banks. These recent headwinds to oil are likely to quickly become tailwinds, as supply shocks, buoyed demand and OPEC+/Russian antics are likely to move near term oil prices.
Supply dynamics remain fickle amidst continuing geopolitical tensions. Russia’s actions directly contributed to the whipsaw in oil over the past year. The exponential rise in oil prices were masked by the expectation of a future severance of Russian supply. In reality Russian oil still flowed post invasion, legally subject to price caps, and illegally filtering through offshore cargo swaps. In the temporary gap of Russian supply and inflationary pressures, developed nations depleted some 250 million barrels of strategic reserves over the past year. All the while as prices fell, capital investment followed, with US Rig counts dropping close to 14% from November 2022 highs. Offloading of refiner supply increased markedly, as higher interest rates drove refiners to pass on higher storage costs.
Global demand, while in question ahead of a potential recession, has buoyed in 2023. Easing Chinese policies and Indian growth pickup has countered uncertainty in developed markets. However, while developed market demand remained stable, inflation and global central banks have weighed on future demand growth expectations. With the suspension of the US debt ceiling and low oil prices, the US has started re-stocking strategic reserves. Falling inflation expectations, peaking interest rates and a delayed/mild recession would all be supportive of oil demand.
The possibility of an instantaneous disruption of Russian supply could be the first domino towards price movement. OPEC and independent Saudi planned cuts into summer months are fluid, as they’ve already reduced close to 4m barrels per day since October 2022. Recent investments and government subsidies in renewable energy will likely take considerable time to bear fruit. In the meantime, with continued resilience in global consumer spending, Asian demand growth and global supply uncertainty, we believe oil prices will move higher over the coming 6-12 months.
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