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Signs Point to More Gains for Oil Prices

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Benchmark Brent crude has surged by more than 50% so far this year to over $120 per barrel, and there are ample reasons to believe it will keep pushing higher. The increase in energy prices over the past two years has been the largest since the 1973 oil crisis, according to the World Bank. And like the 1970s, the market is in a supply-side crisis, which means that prices can still go up even if the global economy slows and demand subsides. With Western embargoes on Russian oil and continued weak upstream investment levels, supply shortages are expected to last well into 2023. Goldman Sachs is now forecasting Brent will average $140 per barrel between July and September, up from its prior call of $125/bbl, and $135/bbl in the second half of the year, up $10 from its previous forecast. "We believe oil prices need to rally further to normalize the unsustainably low levels of global oil inventories, as well as Opec and refining spare capacities," Goldman Sachs strategists wrote this week. Indeed, most analysts think the only way to fend off higher prices is to reduce fuel demand. Energy Intelligence data show that refining Brent crude in Europe yields an average profit of $27/bbl. These record margins will encourage refiners to run at the highest possible levels, but they might not be enough to meet summer demand, let alone replenish already-low inventories. With the summer driving season in full fledge, product stocks are expected to drain even faster. Years of underinvestment in new refineries are now showing. Global refining has lost nearly 4 million barrels per day of capacity since 2019, almost all of it in Europe and the US.

Crude releases from OECD strategic petroleum reserves — mainly from US stocks — have helped mitigate supply shortages. But they are a short-term fix and tend to delay the necessary demand adjustments. Opec-plus is increasing output, which will alleviate some of the price pressure, but its capacity is limited — and the real onus is on refined products supply, not crude. Energy Intelligence estimates Opec-plus spare capacity — that which could be mobilized in short order — at only 2.85 million b/d. Saudi Arabia and the United Arab Emirates hold most, while many Opec-plus members continue to miss their production targets, stoking supply concerns.

Meanwhile, it could take higher prices for a longer period to induce demand destruction in this market. In the Great Recession of 2008, it took prices of $120/bbl to trigger demand destruction. In today's money, factoring inflation, it would require at least $150-$160/bbl, assuming everything else is equal. Aggressive interest rate hikes from central banks are likely to hit the market before that happens, prompting a big but necessary slowdown in demand growth to slay inflation.

The bigger question is how the oil market will address the long-term structural issues on the supply side. Even with today's higher prices, most producers are reluctant to undertake new upstream projects with long lead times due to concerns about future demand and the energy transition. Investor demands for capital discipline are also playing a big role — even in the short-cycle US shale sector, which in the past served as a key swing producer. With Russian oil off the table in the US and Europe, buyers are now vying for the same barrels in a smaller pool of global supply. This is already visible in the recent hike of Saudi crude selling prices to Asia, where higher demand is expected. This is also visible in the US, where diesel prices in New York Harbor have flared up to more than $200/bbl to prevent too much domestic supply from shipping to Europe, where it fetches an even higher price. Russia's crude output is down by 900,000 b/d since its Feb. 24 invasion of Ukraine, but this partly reflects lower demand from domestic refiners. Russian crude exports are in fact slightly higher than prewar thanks to steep discounts of $30-$35/bbl. Lower runs in Russia have lowered its product exports by 600,000 b/d, and this situation is likely to worsen as the EU import ban and shipping insurance restrictions kick in, which will likely add upward pressure on prices.

Topics:
Oil Prices, Forecasts, Crude Oil, Oil Supply, Oil Demand
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