Since last autumn, oil prices have doubled and are anticipated to continue to increase for the commodity throughout the unpredictable and exceptionally optimistic time.
Prior to the Covid-19 pandemic, the United States was the world’s largest oil producer, with independents and majors driving shale production to ever-higher levels. The United States had become a major energy exporter and was regarded as a swing producer with significant influence over global oil prices.
OPEC is once again driving up prices.
However, as the pandemic subsides and demand resumes, the US industry is no longer what it once was, and it is confronted with constraints that make a major shale boom less likely.
“People were writing OPEC’s obituary in 2015. “OPEC is back with a vengeance,” said Helima Croft, chief global commodities strategist at RBC.
OPEC+, a group of OPEC and non-OPEC oil producers, meets on July 1. It is expected to gradually reintroduce supply into the market. In July, approximately 1 million barrels of oil are expected to be reintroduced. At the moment, the world produces less oil than it consumes.
“One new development is that we are once again beholden to Saudi Arabia. We’ve seen them flex their muscles in both directions. They’ll claim the market is oversupplied and that it’s all speculation,” Again Capital’s John Kilduff predicted.
“In the past, there was a supply response,” Kilduff explained. “The last time it was waiting in the wings was US shale. I believe the problem is that we will face a period of much higher oil prices until the cavalry can ride to the rescue from the Permian.”
Oil prices have reached their highest level since the second half of last year. West Texas Intermediate futures were trading at $73.61 per barrel, up from $73.30 on Thursday. Brent, the international benchmark, was trading above $75.62 per barrel. WTI has increased by 51% this year and by 24% in the second quarter.
Year to date, the Energy Select Sector SPDR Fund ETF has gained 45 percent. It is up 12.5 percent year to date.
“I believe the upward bias in price is driven by a fairly disciplined OPEC and the ongoing lack of spending in the United States,” Pickering Energy Partners chief investment officer Dan Pickering said.
“There are two reasons. One reason, I believe, is that there is less cash to invest, and the other is that shareholders are demanding more from companies,” Pickering explained. “They are compelling companies to drill less and reinvest more of their profits in dividends, share repurchases, and debt reduction.”
Shareholders are also putting pressure on companies. For example, Exxon Mobil lost three board seats to activist firm Engine No. 1, which wants the company to reconsider its position in a world aiming for net-zero carbon emissions. Chevron shareholders voted against management on a key climate proposal, and Royal Dutch Shell was recently ordered by a Dutch Court to reduce carbon emissions more quickly.
“If we don’t have investment and demand is strong, you’re going to have a supply dislocation,” Pickering said. “Prices will have to rise sufficiently to kill demand. That situation might not be in 2021… but it could be in 2023 or something similar. The industry’s challenge is that nobody wants the product, but everyone wants the product.”
More immediately, prices are rising, and RBC strategists believe the groundwork has been laid for a bullish period, following the pandemic’s low prices and supply glut.
“While we see further upside, price gyrations are to be expected in the near term. The current price rally is unprecedented in history, according to a recent report. They added that doubling prices in eight months is unusual, and it has happened only three times in the last two decades, with all of those occurrences occurring between the periods of peak and trough oil prices between 2007 and 2009. In 2007, oil reached an all-time high of around $144 per barrel.
Last year, oil crashed in an unprecedented way, as demand dried up overnight and prices fell. Just before the pandemic shut down the economy in 2020, US oil production peaked at slightly more than 13 million barrels per day. It is currently stable at around 11 million barrels per day.
The market is divided over how much and how quickly the United States will resume production. According to analysts, private companies have been quicker to resume production, but there are signs that other producers are following suit. According to some estimates, the return of US barrels will range between 500,000 and 700,000 over the next year.
Citigroup, on the other hand, expects a higher return from shale. As a result, it does not anticipate a sharp increase in prices. “We expect US production to increase by 1.3 billion barrels per day next year,” Citigroup energy analyst Eric Lee predicted.
“We’re very bullish this year, and we don’t want investors to misinterpret it as the start of a new bullish super cycle,” he said.
The most bullish investors, according to Lee, do not expect a strong recovery in shale. According to Citigroup, Brent prices could reach a high of around $85 per barrel in the fourth quarter, but they should average around $78 per barrel, up from an estimated $77 per barrel average in the third quarter.
Citi strategists predict that Brent will average $67 per barrel in 2022, down from $72 this year.
“We don’t think we’ll make it to $100,” Lee stated. “Three digits seem ridiculous to us. Part of it is due to increased demand… “I believe demand growth will underperform once we exit the recovery,” he predicted.
The demand scenario
But, for the time being, demand is high and expected to rise further in the coming year, particularly as air travel resumes.
“Demand is outperforming, even when you look at mobility data in India and elsewhere,” Lee said. “It’s very strong in the United States and China, and trade growth is really picking up.”
Lee anticipates that the world will continue to draw from inventories throughout the year. “Because demand is beginning to pick up beyond 2019 [levels], you’re getting back to the top end of demand. “You are now back in demand growth mode for at least the next year or two,” he explained.
According to RBC strategists, US inventories, which are arguably the most closely watched in the world, were trending at normal levels as recently as two months ago. However, following a series of significant declines, they are now trending at a very low rate, according to an important industry metric.
RBC strategists note that even before this week’s more than 7 million barrel drawdown, the industry’s supply deficit to that average reached a sizable 24.9 million barrels. This was due in part to the elimination of a 30 million barrel deficit in the Gulf Coast, where crude had been stockpiled during the pandemic.
Prior to this year, crude stocks had only reached a seasonal deficit of 10 million barrels or more three times in the previous 15 years, and had not been this large since oil prices peaked in 2008.
