Oil futures: a perfect environment for tightening of the market?

Oil prices are set for a significant increase as global demand heads for record levels fuelled by the loosening of Covid restrictions in China. At the same time, Russian sanctions are about to start having an effect, creating a perfect environment for a tightening in the market.

This week the IEA, which compiles official government statistics from all OECD countries and several non-OECD members, predicted that demand this year will hit a record high of 101.7 million barrels a day. The agency said that half of the gains in demand will come from China, with the largest area of growth being jet fuels.

Although it is not entirely clear how China’s reopening will proceed, at what speed and in what form, the economic recovery expected from the country’s post-Covid reopening is forecast to create nearly half of this year’s global demand growth.

Market turnaround

The turnabout in the oil market follows six months of decline after the resurgence of Covid in China and the country’s strict restrictions on local movement and long-distance travel quashed the world’s second largest oil user’s demand. Also, rising inflation in developed countries and a relatively mild winter in the northern hemisphere dampened oil demand in the fourth quarter,

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According to the IEA in November 2022 global oil inventories surged to the highest level since the peak of Covid in 2021, mainly in non-OECD countries and as oil on water, that is, oil parked in tankers offshore various countries.

This stock build-up will temper the rise in oil prices in the first half of the year with a stronger price recovery expected in the second half of the year.

The Russian angle

So far Russian sanctions have had relatively little impact on the country’s exports of crude oil but the EU ban on import of Russian oil products due to start on 6 February will be different. Until now Russia has been diverting its unwanted production to Asia and the overall net effect on global supplies has been negligible. It will be different with oil products because Asian countries, in particular India, are busy producing their own oil products and exporting them to Europe and the US and are unlikely to want to buy Russian oil products. This more than any oil sanction so far is expected to force Russia to cut down on production. The lower output is likely to coincide with the increases in demand later this year, creating the perfect storm for higher prices.

Russia and OPEC together increased output last year but once Russian output starts tapering out this year production from OPEC+ countries, that is OPEC plus Russia and several other producers, is expected to drop 870,000b/d. Also, last year the US stepped into the supply gap created by Russian sanctions and it is currently the fastest growing global supplier of oil, running at record high output levels. Canada, Brazil and Guyana are currently also major contributors to global supply growth.

Markets have already reacted to some of these factors and Brent crude prices rose by 10% since the start of this year. The IEA’s predictions will go some way to keep the trend arrows pointing higher.

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