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Could oil prices shoot higher as supply tightens?


The War in Ukraine and the impact it has had on global energy prices has set the economic mood music for 2023. After Russian oil was exsanguinated from the global supply chain, the cost of power spiked and sparked a cost-of-living crisis, most intensely felt in developed markets.

Depending on which agency you speak to we are either close to hitting ‘peak oil’ or set to be reliant on hydrocarbons for decades to come. Oil and gas prices have been volatile in 2023, rising sharply in the first few months of the year and then falling back in recent weeks. Prices have been volatile during the year, with Brent Crude ranging between USD70.06 and USD103.48 over a 52-week period, but down around 13% from this time last year.

Stavros Lambouris, chief executive of broker, HYCM International explains why he thinks oil prices might start to tick upwards in the remainder of the year.

For many analysts, oil prices were set to escalate in the second half of 2023 as supply was set to tighten and lag demand.

In fact, based on analysis by the International Energy Agency (IEA), it was projected that the global demand for oil would experience an increase of 1.9 million barrels per day (mb/d) this year, resulting in a record peak of 101.7mb/d. In the midst of this upswing in demand, the IEA also indicated that the supply of oil was poised to decelerate, despite growing by 4.7 bm/d last year.

Hopes for Chinese rebound

Anticipating an increase in demand and a decline in supply, the forecasts of oil attaining record levels in the latter half of 2023 hinged on multiple key factors. These included the rebound of China’s economy as the nation eased its Covid-19 restrictions and the resurgence of industrial activity worldwide, notably in the US.

However, China’s recovery has not been as expansive as initially projected, and the worldwide growth trajectory is now poised to decline from 3.5% in 2022 to 3% in 2023, which is anticipated to impede industrial activity levels. With this in mind, is the anticipation of a tightening oil market overexaggerated, or will we see oil prices hitting a new peak in the months ahead?

The drivers behind global oil prices

The dynamics that drive oil prices are moulded by an interplay of different factors impacting supply and demand. Any disruption to production levels – and therefore supply – exert a substantial influence on the price of ‘Black Gold’, particularly when organisations like OPEC+ (a loosely-affiliated entity consisting of the 13 OPEC members and 10 of the world’s major non-OPEC oil-exporting nations) collectively agree to steer the market by increasing or decreasing production output levels.

This means that, especially in oil-rich regions of the world, geopolitical events may create disruptions in the supply of oil, elevate production costs and increase prices. Simultaneously, demand is heavily influenced by global economic growth and industrial activity, while the financial markets may also instigate major price fluctuations.

Why oil could shoot higher

Taking these factors into consideration, a notable determinant of oil price trends this year has been Saudi Arabia’s choice, made in June, to reduce its oil production. As highlighted by the nation’s energy minister, this restriction on output was intended to establish market stability. Consequently, Saudi Arabia’s oil production experienced a reduction of 9 mb/d in July, marking a significant downturn from the preceding month’s output of over 10 mb/d. This contraction in production stands as one of the most substantial declines observed in several years and was prolonged on 3rd August.

This initiative aligns with a broader strategy devised by OPEC+ aimed at curbing oil output throughout the course of 2023. Even before Saudi Arabia introduced its own output restrictions, OPEC output is set to decline by 3.66 mb/d in 2023, accounting for almost 4% in global demand. As supply falls, prices could rise if production fails to keep up with demand.

This is corroborated by the IEA, which indicates that supply did in fact fall in July by 910,000 barrels a day, while demand is on track to reach unprecedented levels. Largely, this is down to a boost in demand from air travel, but an uptick in petrochemical activity in China (the largest importer of crude oil in the world) also indicates that oil demand is on track to hit 102.2 mb/d this year. As a result of this imbalance between supply and demand, one would expect record highs to filter through in the coming months, especially if global economic growth continues to recover.

Record prices & seasonal trends

In reality, however, oil prices have been pressured downwards of late, despite hitting their highest peak in over a decade last May. Indeed, while Crude WTI has rebounded to USD82.243 per barrel (as I’m writing this) from a significant drop to USD67.3 on 12th June, there are evidently factors inhibiting oil prices from currently achieving a record peak.

In terms of supply, it is worth noting that American and non-OPEC+ oil production is gaining momentum. Thus, despite reductions implemented by Saudi Arabia and OPEC+, the overall global oil production is anticipated to reach an all-time high of 101.5 mb/d in 2023. This escalation in production might act as a mitigating factor, potentially tempering significant price increases.

Volatility and uncertainty

Moreover, if the global economy continues down its current path of volatility and uncertainty, the potential for demand to surge to the extent that the markets are expecting could be restrained. This view is supported by recent comment from the IEA’s Secretary General, who pointed out that price surges are currently being counteracted by fears of an impending recession.

Furthermore, recent statistics from China reveal that key metrics such as retail sales, industrial output, and investment are registering growth rates below market projections. Given that China’s influence is purportedly responsible for over 70% of oil price expansion in 2023, the sluggish resurgence of the Chinese economy has the potential to impede oil demand and subsequently impact prices in the forthcoming months.

Finally, oil prices could also be held back by seasonal patterns in the global oil markets. For instance, between 11th July and 18th December, Seasonax charts indicate an average 14.6% decline in oil prices during the second half of the calendar year. Therefore, the prospect of achieving record highs might face downward pressure as we enter the Autumn and Winter months.

Potential for investment

Clearly, the outlook for oil prices remains uncertain, but this should create opportunities for investors in the months ahead. If prices do rise, investors can expect them to surge beyond USD100/barrel, leading to elevated activity in commodities and futures markets. In this scenario, we could see some investors allocating funds towards oil exploration and development companies, as these entities would likely intensify their endeavours to increase oil production and leverage the heightened demand.

Meanwhile, sectors dependent on products or services derived from oil, such as transportation or manufacturing, could experience an upturn, creating potential advantages for investors. For clues as to whether this will be the case, keeping track of inventory levels will be key (the lower the amount, the higher demand tends to be).

Conversely, oil prices might remain constrained by insufficient economic growth and activities, along with the influence of seasonal patterns. Considering this, investors could contemplate shifting their focus towards assets and sectors that typically demonstrate resilience during challenging economic conditions, such as healthcare, technology, or consumer staple stocks.

Alternatively, within the energy sector, directing attention towards renewable energy sources like solar, wind, and hydroelectric power could offer a more sustainable and enduring investment approach. As the global shift towards cleaner energy alternatives gains momentum, companies engaged in the renewables sector might encounter heightened demand and expanded growth prospects, regardless of the direction in which oil prices move.

To conclude, the trajectory of oil prices remains uncertain due to an interplay of factors that could contribute to significant growth, as well as some economic factors that may apply downward pressure. Consequently, making informed decisions and adopting a clear investment strategy will prove pivotal when navigating this volatile landscape.

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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