Tighter than expected market conditions support crude oil Tighter than expected market conditions support crude oil Tighter than expected market conditions support crude oil

Tighter than expected market conditions support crude oil

Ole Hansen

Head of Commodity Strategy

Summary:  Crude oil continues its month-long rally and while the early January jump was driven by temporary supply disruptions, the rally has continued driven by signs that several countries within the OPEC+ group are struggling to raise production to the agreed levels. Adding to this a sector unloved by regulators but very much needed for years to come, and the risk of even higher prices going forward persist.


Crude oil continues its month-long rally and while the early January jump was driven by temporary worries about supply disruptions in Libya and Kazakhstan, a bigger and more worrying development has become increasingly apparent during this time. Besides the surging omicron having a much smaller negative impact on global consumption it’s the emerging sign that several countries within the OPEC+ group are struggling to raise production to the agreed levels.

For several months now we have seen overcompliance from the group as the 400,000 barrels per day of monthly increases wasn’t met, especially due to problems in Nigeria and Angola. However, in their latest production survey for December, SP Global Platts found that 14 out of the 18 members, including Russia, fell short of their targets. According to Platts the 18 members in December produced 37.72 million barrels a day, some 1.1 million barrels below their combined quota.

The rising gap between OPEC+ crude oil quotas and actual production has already been felt in the market with front month futures prices in both WTI and Brent having rallied stronger than deferred, thereby increasing the so-called backwardation, a curve structure that benefits long-only strategies through the positive yield when rolling (selling) expiring futures contracts at a higher price than the next month.

The US Energy information Administration was the first out of the three major forecasters, the other two being IEA and OPEC, to recognize this development. In their January Short-Term Energy Outlook (STEO), the EIA revised their Q1 global inventory outlook from a surplus to a small deficit. The report also showed that global oil stockpiles declined by a massive 3 million barrels per day in December. In addition, the EIA also forecasts that US oil production growth in 2022 would be slightly lower than previously forecast before averaging a record 12.41 million barrels a day in 2023. This in line with the latest Dallas Fed Energy survey were almost 50% of executives at 88 exploration and production firms said their focus was to grow production in 2022. 

The International Energy Agency (IEA) will not publish its Monthly Oil Market Report until January 19, but with its head Fatih Birol saying “Demand dynamics are stronger than many of the market observers had thought” it is safe to assume the IEA will also lower their recent forecast for a 1Q22 surplus of 1.7 million barrels a day and 2 million barrels a day in 2Q22.

Major US shale oil producers such as Occidental Petroleum last year and more recently Pioneer Natural Resources have increasingly abandoned their forward hedging activity. Since the shale oil revolution began more around a decade ago, forward hedging has been a constant feature by many of these oil producers. During periods of ample supply, the idea made sense as forward prices traded higher than the spot market. In addition, the sector borrowed billions of dollars to pump at will, but in order to do so several were forced to hedge some of their production in order to receive their credit lines.

Surging prices since the pandemic low point, and a newfound discipline among producers cutting back their debt has given several producers the financial freedom to manage their cash flows as they see fit. But behind the decisions obviously also lies a belief that oil prices will remain at current or potentially higher levels going forward. Not least considering robust demand and dwindling spare capacity as seen through the inability by several OPEC+ members in raising production.

Despite a continued, but reduced worry about the omicron variants impact on mobility, and with demand for fuel, the outlook for crude oil remains supportive, and we maintain a long-term bullish view on the oil market as it will be facing years of likely under investment with oil majors losing their appetite for big projects, partly due to an uncertain long-term outlook for oil demand, but also increasingly due to lending restrictions being put on banks and investors owing to a focus on ESG and the green transformation.

Global oil demand is not expected to peak anytime soon and that will add further pressure on spare capacity, which is already being reduced on a monthly basis, thereby raising the risk of even higher prices. The timing of which hinges on Brent’s short-term ability to close above $85.50/b, the 61.8% retracement of the 2012 to 2020 selloff, followed up by a break above the double top at $86.75.

Source: Saxo Group

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo Markets
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo Markets is a registered Trading Name of Saxo Capital Markets UK Ltd (‘SCML’). SCML is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871. Registered in England & Wales.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo Markets assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.

©   since 1992