Oil's relentless rally towards $100

Oil’s relentless rally has been almost unstoppable ever since the Covid price war between Russia & Saudi Arabia sent prices tumbling. Taking a look at the weekly chart really hammers that point home:

Textbook uptrend channel over these past couple of years, and eight consecutive weeks of higher closes recently. But as the price of Brent oil approaches the huge $100 psychological level, supply and demand dynamics are getting complicated.

The geopolitical picture with tensions between Russia & the West running high over Ukraine is one key driver. Morgan Stanley’s focused on the economic risks. They note that a potential invasion could lead to a spike in oil and natural gas prices:

“Such a spike would destroy demand, in our view, and perhaps to tip several economies into an outright recession - the polar vortex”

Perhaps more of an outlier than something to use as a base case. Nevertheless, the potential for demand destruction keeps popping up in market commentary. At some point it makes sense that high and increasing oil prices will be too much for the global economy to stand.

After all, the cure for high prices is… High prices!

For now, demand is still robust. Total U.S. commercial crude oil inventories are now a touch over 410 million barrels, which is the lowest level since 2018. OPEC’s latest report also painted a positive picture:

“As most world economies are expected to grow stronger, the near-term prospects for world oil demand are certainly on the bright side,”

The International Energy Agency threw another spanner into the works too. In their latest report, they revised up their oil demand figures for the past 15 years. As it turns out, the world’s been using a lot more oil than they realised…

Since 2007, 2.9 billion more barrels had been used than previously thought. Saudi Arabia & China have long been known for being less transparent than other nations and are largely ‘responsible’ for this. The huge scale of the revision is still striking. The upshot: Global oil inventories are considerably lower than originally believed.

Presuming no demand destruction, the supply assumptions until now have been fairly clear. Inventories running low, OPEC countries struggling to bring supply back online and US shale producers taking it slow and steady as they recover from the prior overinvestment boom and bust.

Can US shale boom again?

This is a crucial question now. Last week, the US added 22 rigs. That’s now a jump of 238 rigs in the past year. The Energy Information Administration (EIA) increased their 2023 US production forecasts from 12.41 million bpd to 12.6 million bpd.

The upturn in oil prices coupled with capital discipline has led to stronger balance sheets for many oil and gas producers. Coupled with rating agency upgrades and low interest rates, many energy firms have been able to refinance at far cheaper rates…

The weekly rig counts will become increasingly important now as markets look for clues that US producers are drawn back in by higher prices. Friday’s jump certainly suggests they’re starting to get involved again. Barring a recession/slowdown, these supply dynamics could be the main driver of the oil price in the coming months.

Not investment advice. Past performance does not guarantee or predict future performance.