Thoughts on crude oils next big moves given the economic landscape?
Title says it all, want to start a discussion on this given the recent bump of oil given the Ukraine Russia war, curious if anyone has thoughts on volatility going forward
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I am biased as my career is directly correlated to crude prices...but I'll try to mitigate some of the biases I have in my thoughts below.
Demand side: rubber seems to be hitting the road with a lot of survey data showing that EV adoption will be a lot slower than previously thought. The continued use of ICE engines therefore provide at least a floor on oil demand. I don't see an increase in petroleum demand from today to be sure, but I think some of the re-forecasting of adoption of alternative energy sources extends the runway from a demand standpoint of traditional fuel sources.
Supply side: oil wells are getting worse. JPM does a good series of sell-side research reports that showcase well productivity by certain vintage years. Wells drilled today are much less productive than wells drilled 3 / 4 / 5 years ago on a cumulative EUR basis. Mathematically that means you've got to funnel a lot more capex into your development program to just maintain production, which the publics have thus far been hesitant to do because of investor pressure to return cash. Wildcard here is the privates, but you've seen quite a few consolidations of privates in the last few weeks even (3 EnCap companies bought by OVV, two NGP portcos rumored to be for sale, 2 more EnCap companies for sale, etc.) so if those change hands you've taken a big chunk of the private production off the market as the publics will scale back the activity (i.e. OVV will be releasing all rigs on the acquired assets and only be using their existing rigs). Combine this with still elevated OFS costs (completions are coming down, but drilling costs are still near record highs) and the likely scenario is a drop in activity that tightens supply side.
What this reads through to me is that demand will be steady with supply slightly coming down, which should be slightly bullish for prices. I say slightly because a lot of the discipline mentioned in my supply point gets thrown out the window with $100 oil (a rising tide lifts all shitty economics), so at those levels the market corrects itself pretty quickly. What I think happens is a normalization (much like we've seen the last 3-4 weeks post-banking fiasco) of $75-$85 oil. It's a healthy level where everyone in the value chain is able to make money without undue stress on any of the individual parts of the value chain.
Obviously a big wildcard here is 1) recession or 2) war....in 1 the demand side collapses which tanks prices....in 2 the demand side grows materially and prices respond. So need to probability weight both of those independently but I tend to lean towards neither of these being high probability events.
Again, I am biased. Happy to discuss / engage with anyone who has differing viewpoints.
What's your take on the probability of war and recession, I feel like in terms of big moves these are the two most likely to occur in the near future as you mentioned. Particularly Ukraine and Russia
With regard to the war, both crude and product sanctions are in effect. And Russia still makes the same amount of oil and products and just sends it to other places. And that’s exactly what the West wants… to wash their hands but let someone else get their hands dirty. So unless there’s a radical escalation of the war like a nuke that causes India to stop buying from Russia, it looks like business as usual. The only change from there then is if Russia can keep production levels up now that Western engineers have left- they have so far but we will see.
First, know that supply and demand are within 1% of one another- and even if a 1% imbalance lasts for 6 months, that’s about 150 million barrels which is the difference between 100 dollar oil and 50 dollar oil. What this means is that big moves happen on minor imbalances, and minor imbalances are by their nature difficult to predict. So remember that when you see researchers from banks go on tv and say with confidence that it’s going to 100 or that it’s going to 50, often in the same week. They cannot be both right.
So that caveat aside, the main factors that determine this at present in the short term are on the supply side- OPEC discretion, resilience of Russia to produce without Western tech, and US shale potential (as noted above, lots of talk around a slowdown). The main factors that affect this on the demand side are Chinese opening after zero Covid (other countries have recovered already) and the expansion of refinery capacity (refineries are the constraint between crude and products), and demand destruction from a possible recession.
These things are extremely difficult to net to one another, but my view is that crude catches up with products due to refinery expansions. So the spread between crude and products narrows. What this does is suck up more crude to make more products. And because the expansion in refinery capacity greatly exceeds any realistic gain in demand, crudes appreciate against products.
And as we see this refinery demand occurring alongside a Chinese reopening paired with a short sighted OPEC cut, oil goes up. But it should be short lived. As that extra production of products saturates product demand, and a high flat price destroys demand, and OPEC itself will want to prevent too high a price from destroying demand long term by increasing their production targets. That plus the economic impact of a possible recession pushes oil down again after that. That’s where I stand right now.
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