It is always amusing to read sell-side analyst notes at extremes, the mere sensationalism of events almost becomes self-fulfilling as it compels the others to follow suit, lest they be left behind.
This is what is happening in the oil markets, currently as one by one, each sell side house is calling for $90-$100/bbl. Brent oil, some even say, could hit $120 a barrel. The desperation and fear in the notes is almost synonymous with the one witnessed during the the depths of the COVID crisis last year when WTI plunged to -$35/bbl.
Do we sense a theme?
The supply side is very easy, or rather simpler, to forecast, as it is the "known." Projects do not just spring up overnight and most companies are usually quite transparent about their drilling plans. The capacity of the bigger state producers is also known, their theatrics and games might be harder to predict, but at the end of the day, it is all about budgets, revenues, and economies of scale. The harder one to forecast is demand. That is because it never stays constant. We saw how demand swung around violently in 2020, going from 1.5% to -10% to now up 5%. Oil is a commodity and it is cyclical, more importantly it is seasonal.
What happened in 2020 was exceptional. Oil prices going to negative was a one off as physically Oil was unable to settle in a short period of time. That is how Commodities work. If you have too much of it, there is no floor value, and if you have too little, you will pay to infinity even (electricity and power recently). The demand surge of last year and this year was also exceptional given the amount of money central banks pumped into the economy, together with the fiscal policies announced. The combination of the two has caused a massive surge in M2 Money supply, around 25% year-over-year. This is a 40% increase over the last two years, the largest two-year increase going back to 1959. This is not normal. The demand surge seen across Commodities and products is not something that can be repeated, let alone forecast.
There is no doubt a shortage and tightness in select commodities and products. This is evident in container and port delays, supply chain tightness and price of every commodity and good shooting higher, given the surge in a very short period of time. But as Economics 101 has taught us, what happens when prices start shooting toward infinity or supply falls short, we start to see demand destruction. That is the only solution by the time supply side gets time to catch up. Eventually one side always gives in.
Global oil consumption has bounced quite a bit, but is still a bit below pre-COVID levels, but what most do not talk about is global production. This is still well below pre-COVID levels. There has never been a shortage of oil, look at 2014 and 2018. In fact, producers have been withholding and keeping barrels out of to keep the market since then to keep it "balanced." U.S. Shale lost about 2,000 barrels per day (mbpd) of permanent oil production since COVID and U.S. producers are slow at restarting it, given they have had their wrists slapped by their investors, even though these prices make great economic sense. This is window of opportunity for OPEC+ to really "maneuver" the market as they are literally the swing producer.
It has been a year and half since COVID began, and the economy is firing on all cylinders, prices have skyrocketed to even before cycle highs, and yet they are worried that demand is not strong and are deliberately slowly releasing all the 10 mbpd of oil they took off last year back onto the market. Why the rush, when higher prices means more money for them? Especially if the trend is gradual.
There is a risk that if demand stays this strong, and producers hold back, OEPC+ holds back all the oil and we also get a cold winter snap, prices can surge higher. But there are a lot of ifs in that sentence. This is the basis of the notes we have seen forecasting the same flat growing oil demand assuming no demand destruction or slowdown post all the stimulus driven expansion. From that perspective, of course oil prices can surge higher. But time and again we see that when demand slows and prices start to fall, they will then take their demand numbers down and calling for lower prices, after the fact of course. Rinse and repeat, the process starts again.
It is easy to see the extremes at both ends, but the real analysis depends on what the future demand equation will be. This is where most academic institutions and analysts lose out as their job is not to predict or make a call as such. They are the like the Fed, they only react to a certain set of conditions after it happens. We all know markets do not work that way.
