In the last few months, we have seen strong upward movements in the main crude oil benchmarks – WTI and Brent. This started with the advent of positive news at Covid that vaccines under development were extremely effective, promising an end point for the spread of the virus. This upward trend in oil was driven by the gradual decline in US shale production and stocks over the same period.
Data-EIA, Graph by Author
Finally, the move in early January by OPEC + to restrict production until mid-2021, and an extra “gift” from Saudi Arabia to remove another 1 million BOPD from the market, provided the impetus for WTI to rise steadily to the US $ 50. In this article, we will discuss the main reasons why we believe the upward trend in oil will continue this year. Because?
Demand will return
Despite the current blockages that inhibit demand, the trend is greater. As the implementation of vaccines increases the population pool that is immune to the virus, commercial activity will resume the creation of demand for refined petroleum products. The graph below shows the forecast of the EIA, the Energy Information Agency, of the trend for refined products over the next two years. For gasoline, the primary engine fuel used in the U.S. gradually rises in the second half of 2021 and then moderates in 2022, just below 2019 levels. The EIA makes some assumptions about work at home and reduced travel in this forecast. The forecast is not so robust for aviation fuels, showing slight growth in 2021, but a return to levels close to 2019 in 2022. Total demand increases and slightly exceeds 2019 levels in 2022. Related: The pandemic could lead to a major oil supply crisis
This is high for oil prices.
The political and macro environment will push supply down
The elections have consequences. The concentration of power over the next two years, with Democrats in control of the three branches of government, will make increases in US production very unlikely. From the recent highs of 2020, where the US produced more than 13 mm BOPD, production in response to low prices dropped to 11.0 mm BOPD. We will see an improved and stricter regulatory environment in the years to come. The US will be firmly placed on a path where renewable fuels are rising at the expense of petroleum-derived fuels. The United States’ anticipated re-entry into the Paris climate agreements will only exacerbate this trend. Fossil fuels will become scarcer, which means rising prices.
OPEC + surprised the world with its determination to finally raise prices. Using its power as one of the three largest crude oil producers in the world and its undisputed position as the lowest cost producer in the world, Saudi Arabia unilaterally chose to withdraw another 1 million BOPDs from global markets in addition to its OPEC + commitments. It was this action that moved oil markets above $ 50 for the first time since the beginning of March 2020. What this strongly suggests is that the cartel is resuming its traditional role of setting oil prices for the world.
The decline in the US supply will firmly return OPEC + pricing power. The $ 50 recently earned is likely to be a minimum price going forward. The saturation we have had to deal with in the past few years will continue to dissipate as US shale producers’ capital constraint maintains the general downward trend. OPEC + really has only one mission – to provide maximum return for its members, balancing supply and demand. The current passion of Western economies for climate change is less motivating for the main countries that make up OPEC +. Their economies are mainly driven by the export of crude oil and everyone wants higher prices.
OPEC + resuming the role of oscillating producer is optimistic for oil prices.
Commodity prices will skyrocket
Last fall I wrote a Oilprice Article where I stated that there may be a commodity boom on the horizon. There is no commodity more fundamental to the world economy than crude oil. Among the things that drive oil, in addition to scarcity, is the fact that it is quoted in dollars, which makes it very susceptible to inflationary pressures.
Market Watch
The dollar index fell during the past year, but has recently been supported with a week-long uptrend. A stronger dollar represents a rise in oil prices because you get less oil for the dollar, which means that you need to spend more to get the same amount. This is inflationary and, as noted above, oil is very susceptible to this pressure.
Related: Saudi Arabia starts new Middle East oil bull race
Nor can we ignore the amount of stimulus that the global economy has unleashed in response to the virus. We believe that, as the infection rate begins to decline, governments will begin to address the historically low interest rates that helped provide liquidity in the pandemic. There is a price to be paid for the wave of money distributed so far, and the additional stimulus will come when the Biden government takes control of the economy. Classical monetary theory tells us that part of the price is probably inflation.
There is a temptation to compare this crisis to the financial crisis of 2008. There, the Treasury borrowed about $ 500 billion to provide the liquidity that prevented the collapse of the financial system. So far, in the United States alone, nearly 4 trillion dollars of stimulus has been authorized, with other actions taken by the Federal Reserve to ensure that institutions, corporations and small businesses have the funds they need to operate. As noted earlier, the Biden government is just getting started and has discussed more trillions in financial stimuli for the economy.
Market Watch
Commodity prices increased sharply between 2008-2011 due to the stimulus provided in response to the 2008 Financial Crisis. The same index below shows that in the last six months the index has increased sharply. This increase is certainly related to the amount of stimuli provided and expected to be provided by the global economy.
Market Watch
As noted earlier in this article, crude oil is the most fundamental and volatile of commodities.
A high or high price environment for commodities is strongly optimistic for higher oil prices.
Your takeaway
The brevity prevents us from discussing all the factors that may impact oil prices in the short term. With the information provided in this article, we believe there is a strong case for a continued moderate increase in oil prices for the remainder of this year.
In the long run, we expect an increase in oil prices, as the reduction in supply cannot meet the growing demand. We see this as inevitable, as I noted earlier Oilprice Article. The underinvestment of major international oil companies in the past six years will create a scenario in which the industry simply will not be able to respond to rising demand in a timely manner.
By David Messler for Oilprice.com
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