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Oil Takes Aim at $100 as Supply Hurdles Mount

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A confluence of bullish fundamental drivers is pushing oil closer to $100 per barrel, with geopolitics adding another layer of upside risk. Omicron has left global economic growth largely intact, while the tail effect of massive pandemic stimulus programs is still floating around, which will push oil demand to 240,000 barrels per day this year — having a more pronounced effect in the first half. Low product inventories and pervasive market doubts about how much oil spare capacity is available are adding further upward pressure, making the prospect of triple-digit prices more tangible. Non-Opec will add 2.1 million b/d in supply this year and another 1.5 million b/d in 2023, covering most demand growth. But concerns remain about upstream investment levels due to energy transition pressures. The European Central Bank recently said the transition would inevitably prompt persistent oil price inflation, calling EU countries to speed up their decarbonization efforts. Energy Intelligence counts 3.5 million b/d of immediately available spare capacity — available in 30 days, sustainable for 90 days — but sees it falling to 2.5 million b/d by year's end if Opec-plus maintains its current program of supply additions. Industry sources in the Mideast Gulf estimate current spare capacity at a more precarious 2.5 million b/d.

Tensions in the Middle East and political discord between Russia and Ukraine have brought back about $5/bbl of geopolitical risk premium to the market. The prospect of potential supply disruptions has drawn risk capital back to the fray, as big hedge funds can trade on the early signals that geopolitics provide. Bets on oil prices rising to $100 and beyond are piling up. Brent and West Texas Intermediate (WTI) combined have more than 155,000 contracts — or 155 million barrels — betting on the price breaking to $100 in either June or December 2022. Brent’s open interest shows 31,500 contracts out on $100 in June, 15,000 betting on $120, and 13,000 on $125. For WTI, the broadest exposure is in the $100 WTI December 2022 call. The current thinking is that if oil is trading at $90 this winter, it can move higher when peak summer demand hits. Strong margins, meanwhile, have enticed refiners to chase low-energy, low-sulfur barrels to max out their runs at minimal processing cost and meet unabated demand for transportation fuels. Outside of China, little refining capacity is now idle.

There is no physical shortage of oil for now, merely a quality mismatch between the widely available heavy, sour crude that Opec-plus is releasing and the sweeter grades refiners want. Tightness is boosting sweet crude differentials and eventually feeding into higher benchmark prices, putting a solid floor under an already-ebullient futures market. Brent is now trading March barrels that will process in May, which means the price uptrend could spill into the second half of 2022. Lower natural gas prices after winter could help reduce refiners' appetite for sweet crude. And if capital expenditure is picking up globally, as oil-field services giant Schlumberger suggested recently, more sweet supply should be available, including from US shale. On the sour side, the market has also priced in the addition of 1 million b/d of supply later this year if a nuclear deal is struck with Iran. But prices would nudge higher if this fails to materialize. Similarly, supply additions expected from Brazil, Suriname and Guyana this year are priced in, and any delays would likely drive prices higher.

Macroeconomic factors could still still stop Brent from straying too far above $100/bbl. Covid-19 variants remain a threat to demand, particularly in countries with "zero Covid" policies like oil demand hub China. Higher oil prices could also prompt demand destruction if they are too much for consumers to bear. Brent's breach of $90/bbl this week could be the tipping point, making $100-plus unsustainable if not unattainable. The US Federal Reserve aims to raise interest rates three times in 2022 to deal with persistent inflation. But if inflation overshoots because of higher oil prices, monetary actions could be faster and tougher. A faltering equity market could also flip overall market sentiment and prompt a rush to the exit by some of the larger oil bulls. The International Monetary Fund has lowered its 2022 global GDP growth forecast to 4.4%, down half a percentage point below its prior estimate.

Topics:
Oil Prices, Crude Oil, Oil Forecasts, Oil Demand, Oil Supply, Oil Inventories, Oil Spot Markets, Oil Products
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