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How Oil Could Hit $200 And Beyond (Part II)

Published 03/16/2022, 07:14 AM
Updated 07/09/2023, 06:31 AM

In yesterday's post I looked at Vladimir Putin's invasion of Ukraine and the ways in which it threw a spark into the powder keg of the global oil market, sending the prices of WTI and Brent barreling toward new record highs. As the war grinds on without a quick resolution, we could see even more explosive gains ahead.

Today I'm analyzing the supply and demand trends that got us here, in order to provide a roadmap for what we might expect from oil markets going forward.

Oil Demand on Track for New Record Highs

As recently as late 2021, the fashionable opinion on Wall Street said that oil demand had peaked with the pandemic, and it was all downhill from here. One well-known asset manager overseeing tens of billions of dollars famously called for crude oil to go the way of “whale oil”:

Cathie Wood Oil 'Call'

Fast forward 18 months later, and the oil skeptics couldn’t have been more wrong—with U.S. demand running consistently above pre-COVID levels and clearing new record highs just last month:
US Oil Consumption 2019 vs 2022

More impressive, these new highs showed up before peak seasonal demand kicks in during the summer driving season, which could unleash more upside from here.

Looking ahead, another source of potential demand upside could come from a further rebound in air travel. The chart below shows that U.S. air travel remains about 15% below the pre-COVID levels of 2019:

US Air Travel 2019 vs 2022

With COVID restrictions fading, many analysts expect U.S. air travel will stage a full recovery at some point in 2022. If true, this could help secure additional new highs in U.S. crude demand.

Finally, the rest of the globe is following America’s lead. The IEA’s latest estimates indicate global demand will grow by 3.2 million bbl/d this year to 100.6 million bbl/d. Meanwhile, the EIA projects a new record high in global demand by Q3 of this year, with further new highs in 2023 and beyond:

Global Oil Demand 2019-2023 (est.)

In other words, peak oil consumption is nowhere in sight. And with economies re-opening around the world, the world will need over 3 million bbl/d of new supply this year alone.

On that note, let’s consider the supply side of the equation…

U.S. Oil Production Stalled, and Higher Prices Might Not Help

Despite the best pricing environment of the last decade, U.S. oil production remains stalled out at 11.6 million bbl/d. That’s about a million bbl/d shy of pre-pandemic highs:
US Oil Production Stalled

This reflects a 180 degree change from the dynamics of the last decade, when shale drillers unleashed millions of barrels of new production growth at $50–$60 oil prices.

As I've described previously, the reason for this change is two-fold: lack of capital investment, and perhaps more importantly, a lack of inventory. Shale drillers have simply exhausted core inventories in many of the key basins that boosted U.S. production during the shale boom, like the Eagle Ford and Bakken shales.

Today, the Permian basin in Texas is the last bastion for U.S. production growth. Despite adding over half a million bbl/d in new production since mid-2021, the Permian is struggling to offset declines in conventional production and the stalled output from all other U.S. shale fields:

US Shale: Permian vs All Other Production

Given the exhausted inventory in shale basins outside of the Permian, it’s not clear that higher prices can solve this problem. Meanwhile, even if operators want to put rigs to work, the oil patch is dealing with an acute shortage of inputs across the board, ranging from labor to steel piping to frac sand.

The same supply chain constraints slowing down auto manufacturing and home construction are showing up in the oil patch, and there’s no easy fix here. This confluence of factors explains why, despite the recent, biggest weekly gain in crude prices ever, the U.S. oil rig count actually fell by three at the same time, though more recently it's once again crawling higher. Still, remains about 24% below pre-COVID levels:

US Oil Rig Count

Finally, there’s the OPEC+ coalition, which is also struggling to boost output.

OPEC+ Capacity Hit by Global Capital Retreat

In the wake of the COVID-19 outbreak, OPEC+ balanced the oil market by cutting a record 9.7 million bbl/d of output. As demand rebounded, the group agreed to release 400,000 bbl/d of new supply each month, starting in July of 2021.

But for the last several months running, many of the participating countries have struggled to hit their production targets. In January, the IEA estimated that OPEC+ undershot its production quota by 900,000 barrels per day.

A big part of this shortfall can be attributed to the Western backlash against fossil fuel development. Historically, a substantial portion of OPEC+ oil production has been developed by western capital—primarily from the global supermajors. But now, slashed capital budgets among Western oil companies is creating ripple effects around the globe, as energy expert Julian Lee explained to Bloomberg:

“Persistent production shortfalls in countries like Nigeria and Angola are not the result of maintenance… rather, they reflect dwindling capacity resulting from lack of investment in exploration and development. So the shortfall will persist. In fact, it’s going to get worse, as more and more countries run up against capacity constraints and struggle to lift production.”

Thanks in part to downgraded estimates for OPEC+ production capacity, Morgan Stanley) forecasts the world’s spare capacity will shrink from 6.5 million barrels a day a year ago to below 2 million barrels a day by mid-2022:

OPEC+ Spare Capacity

Critically, these space capacity estimates were made before the Russian invasion of Ukraine. So even assuming zero disruption to Russian supplies, the oil market was set up for a dangerous drop in spare capacity to under 2 million bbl/d by year-end.

Finally, let’s consider the potential impact on the market in the case where Russian exports remain impaired going forward.

A Demand Destroying Price Spike Could Take Oil to $200+

Every commodities bull market is born from a supply/demand imbalance. The price mechanism attempts to solve the imbalance in one of two ways: incentivize more supply, or reduce demand.

Over the past year, the oil market has signaled the need for more supply (or less demand) through a steady grind higher in prices. And yet, despite oil reaching multi-year highs above $90, producers have struggled to add enough supply. As discussed in this two part article, many of these production struggles can’t be solved by higher prices in the short-term.

Meanwhile, demand continues rebounding across the globe.

Now, the threat of losing up to 4.8 million bbl/d of Russian exports could take the supply side of this balancing act off the table. In the event of a total loss of these Russian exports, even with every other OPEC member maxing out their production capacity, the market could still face a crippling supply deficit exceeding a million bbl/d.

In that scenario, widescale demand destruction would become the only mechanism available to balance the market. It’s anyone’s guess how high prices would go in this scenario, but $200 could be just the beginning.

Of course, that scenario wouldn’t be good for anyone. For the sake of everyone on the planet, we should hope that the Russian-Ukraine situation gets resolved as soon as possible.

But for investors, this potential scenario has become one of the key risks that could impact every global asset class, and one which appears to be growing in likelihood with each passing day.

This content was originally posted at the Ross Report.

Latest comments

Supply and demand. don't be coy , seasonal driving single biggest reason we'll see just as Goldman Sachs says, $120 oil soon. I think, 120 average prices by end of month and we'll be to 150 by summer. That's to peak driving season July 4. After thT , if higher, it's because supply outpaced by demand, perhaps, air travel picks up and even more folks working will drive oil demand too. I think, 3.5% unemployment = $150 oil
Its all bidens fault
Trudeau’s ridiculous energy policies contribute in a huge way.
because Biden's one year as pres changed everything that happened before like the Saudi prince dumping into the market to plummet prices - looks like he was smarter than trump
nobody wants the price of fuel reaches that level.
I agree... a demand destroying price rally isn't good for anyone (outside of oil traders).  But definitely a risk that all investors needs to be aware of, as the implication would likely be a global recession.
 producers wouldn't complain either and realistically the markets needs a cool down - fed money printing needs to get some overall market adjusting - the recession was already in the cards - this is just going to advance that timeline from 4th q/ 1st q 2023 to q2/3 2022 which older investor were already aware of - don't need a Econ degree to see this coming
Those who have invested in oil and has have millions of reasons to say it will touch even 1000 with charts and stories but the reality that surfaced last day was demand current is half that of pre pandemic so what is the inference , its crude aint supposed to be above 50 dollars
hope you don't have to fill your cars tank on supposedlys
Europe and U.S Oil dependency to Russian, Islamic Republic of Iran and Venezuela had to be stopped long time ago. Our greed and ignorance make them dictators, corrupt and rich, now is too late... I think we should expecting hardship from now on...Oil price is gonna stay high for a while...You`ll see..
Yes capital investment has taken a hit, but US majors growing ESG mandates, the lack of fracking crews and the roadblocks imposed by the Biden Administration to appease his radical left progressive constituency have also contributed to impair production growth
The reason there is very little shale production isn't because of lack of capital investment. Even management from OCC admitted as much. They said what happened was they invested tens of millions of dollars into shale facilities only to see demand decline to point shale facilities weren't even profitable, so they had to shutter facilities losing all that invested capital. They said when demand warrants it, shale facilities will once again be very profitable and will come back online. Oil is not going to touch $200 a barrel for a very, very long time. There's far more oil, natural gas and coal than previously thought. It seems your title is more click bait than anything else. I recommend finding the article about Occidental Petroleum Corp and their take on shale and why production is down. I'd say the oil execs know better than anyone why they are or aren't producing.... and the reason is what I just said Occidental said.
Click bait. Correct.
“…when demand warrants it…”? When does THAT happen? You saying there’s not enough demand to warrant it? I think youve misunderstood OCC. this all comes back to hostile policy and ESG investor demands not to grow capital investment.
We'll see, CSGreer, how right (or. yes, wrong) you are, seasonal driving demand not even started yet and of course pre pandemic levels not reached, we're just getting started on seasonal driving season. Peak usually is July 4 but this is a new normal and more drivers (traffic is nuts all hours WA state, Seattle I-5, 167, it's got worse even though we just spent billions on our freeway upgrades). You'll see, it's both production oil finds lacking + Biden tamp down on oil leases + biggest is just more folks working post-pandemic, hence, driving more, this is all why we will, indeed, see $120 average price spring (so few days away, it's why jumping $5 now) as Goldman said this # but I gotta feel $150-200 in offing as we approach sumner and more just want out of house, "revenge spend" etc from Covid cooped up so long
Ross's 350usd lol trust me middle east war starts
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