Hi readers! In this week post, I’d like to step back for a bit to show the context of why I think, we are in a long term oil bull market, not one that was caused due to the Russian invasion
The Misunderstood Dynamics of the 2022 Oil Rally
Mainstream Misconceptions and Russia’s Role: Contrary to popular belief, the 2022 rally in oil prices was not a result of supply disruptions due to Russia’s invasion of Ukraine. Instead, Russia used surging oil exports as a source of funding for increased military spending. The Energy Institute revealed that Russian oil production in 2022 was up by 1.8%, near the highest levels since the late 1980s. There was a similar ramp-up in the waning days of the USSR, amidst heavy military spending during the Cold War.
Russian oil exports actually rose last year, despite initial fears.
In response to Russia’s invasion, the U.S. sold 275 million barrels from the Strategic Petroleum Reserve (SPR), the largest release in history. The SPR now holds less than 350 million barrels, the lowest since mid-1983.
Global Oil Market Dynamics: Supply and Demand Analysis
Demand Trends and Assumptions: Analysis shows strong global demand in the first half of 2023, along with OPEC slashing output. OECD oil demand has increased due to economic reopening, while China’s demand recovery reflects its Zero COVID strategy. However, disappointing economic data from China might introduce downside risk, although stimulus from the Chinese government could reverse this.
Non-OPEC Supply and OPEC’s Role: OPEC expects modest non-OPEC production growth over the coming year, with 770,000 bbl/day growth expected from the U.S. The “Call on OPEC,” or the oil quantity OPEC must supply to keep the market in balance, is key. When OPEC pumps less, global inventories decline, and vice versa. In Q3 2023, the cartel sees the call on OPEC rising, which may result in significant draws in inventories globally and higher prices.
The Ongoing Oil Market Tightening
Signs of Tightening and Russian Impact: Bloomberg estimates show OPEC produced about 27.79 million bbl/day in July 2023, almost entirely due to Saudi Arabia’s cuts. This leads to a potential deficit of 2.2 million bbl/day, implying a significant draw in inventories globally. Meanwhile, Russian seaborne oil exports have started to fade, contributing to OPEC supply constraints and seasonal demand ramp-ups, resulting in a significant tightening in the global oil market.
Analyzing Past and Present Trends: Historical data from the 2007-09 Great Recession and subsequent trends provide insights into the current situation. The only plausible way to understand sub-$70/bbl WTI prices as of late June is a significant drop in global demand. However, such a demand drop would require a recession on the scale of the 2007-09 Great Recession, which is unlikely.
The Inevitable Turning Point: Looking Ahead
Critical Quarter and Price Implications: Q3 2023 is deemed critical for the global oil market, with a projected deficit leading to likely much higher prices. Weekly data shows inventories falling, and U.S. motor gasoline inventories have reached the lowest levels in more than five years.
Back to Russia and the Bottom Line: Russian seaborne oil exports, after initially ramping up in 2023, have faltered this summer. Coupled with OPEC’s supply constraints and a normal seasonal demand increase, a significant tightening in the global oil market is unfolding. Looking at previous trends and market balances, a new turning point seems imminent.
In conclusion, the dynamics behind the 2022 oil rally are multifaceted and often misunderstood. A careful analysis reveals that the situation is not merely a consequence of supply disruptions, but rather a complex interplay of global demand, supply dynamics, political decisions, and historical trends. The insights provided here may help in understanding the future trajectory of oil prices.