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Oil’s Price Bound To Rise: Just Wait For The Demand Recovery

By Dylan Banchetti/Investing.comCommoditiesOct 02, 2022 08:27AM ET
www.investing.com/analysis/oils-price-bound-to-rise-just-wait-for-the-demand-recovery-200630551
Oil’s Price Bound To Rise: Just Wait For The Demand Recovery
By Dylan Banchetti/Investing.com   |  Oct 02, 2022 08:27AM ET
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  • Oil’s late decline is sentiment-driven, not related to economic fundamentals
  • Supply is already at maximum capacity, with no short-term or long-term growth prospects
  • Any pick-up in demand will break through the supply ceiling putting massive upward pressure on oil prices

During the third quarter oil prices have followed the market’s steady decline, falling by 25% since early July. And yet, oil supply seems to only be getting tighter and tighter with little-to-no chance of loosening any time soon. Supply is stalling while demand is set to pick up, hinting that the upshot in prices we saw as Covid restrictions loosened might happen all over again.

Crude Oil Chart Since Mid-2020
Crude Oil Chart Since Mid-2020

Bearish Sentiment, Bullish Fundamentals

Much like most other financial instruments in 2022, oil’s downward path has more to do with market sentiment than with supply and demand dynamics. The Federal Reserve’s aggressive policy, a benchmark for other central banks, has investors bracing for a recession. Its hikes have also pushed the USD to 20-year highs, making USD-priced commodities (such as oil) more expensive globally.

For weeks now, banks have begun to warn that oil markets will eventually read through the noise and return to economic fundamentals, where all factors point in the same direction: upwards.

JPMorgan is among the most bullish, with the bank’s oil and gas analysts saying they expect Brent to rebound to $101 by the end of the year. Goldman Sachs predicts Brent to reach $125 by early 2023. Morgan Stanley and UBS both revised their expectations downwards, yet their 4Q Brent targets remain at $95 and $110, respectively.

The common thread underlying the banks’ reasoning is tight supply. On all fronts, supply seems to be on a downward trajectory with no signs of growth.

The G7 is steaming ahead with a global oil price cap and the EU’s ban on seaborne Russian oil imports is set to be implemented by December 5th. Russia has already warned that it will refuse to sell oil to countries enforcing the price cap, leaving those aligned with the G7 struggling for supply. Russia will also likely face practical challenges in delivering oil to its ‘new’ buyers (i.e. India & China) given the freeze from Western insurance and tanker services. Either way, sanctions will limit global oil supplies.

In the US, the Strategic Petroleum Reserve is at its lowest level in decades, causing worry in the White House. As of now, it seems that releases are set to fade out this fall, with final deliveries potentially reduced or even canceled.

Strategic Petroleum Reserve Chart
Strategic Petroleum Reserve Chart

Supply Side Pressure Continues

More bad news for the supply side - just last week rumors emerged that OPEC+ might reduce output should Brent drop below $90. Analysts estimate the cartel would need to reduce output by roughly 1m bpd to keep the price up. This comes after OPEC+ already cut their October target by 100k bpd, showing the group’s willingness to respond to changing market conditions. The cartel’s next meeting is on October 5th. With Brent currently at $85, a further cut in production targets shouldn’t come as a surprise.

An analysis of the supply factors paints a bleak image – the market is undersupplied, with little in the way of upside. As Saudi Aramco’s Amin Nasser warned, years of underinvestment in new oil production are beginning to make an impact. And, in this macro climate, energy capital expenditure is showing no sign of picking up. In fact, it is plummeting.

The slowdown in demand explains part of the market’s underestimation of global oil supply tightness. Yet, demand is bound to recover at some point and there are two situations that suggest that may happen sooner rather than later. 1) China (and its 1.4b people) remains largely under lockdown and is bound to reopen by the end of the year; 2) spiraling gas prices will lead to increased demand for fuels (including oil) in the generation of electricity.

The current equilibrium in oil markets is temporary and fragile, held in place by a step back in demand. Any step forward would break through the supply ceiling, putting massive upward pressure on price. It is not a matter of whether demand will recover, but when.

In my next piece, I’ll be sharing an energy company well-positioned to ride the demand recovery when it happens.

Disclosure: The author does not currently hold a position in any oil-related securities. This article is written for informational purposes only. It does not constitute a solicitation, offer, advice, counseling, or an investment recommendation.

***

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Oil’s Price Bound To Rise: Just Wait For The Demand Recovery
 

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Oil’s Price Bound To Rise: Just Wait For The Demand Recovery

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Comments (10)
Adam Cu
Adam Cu Oct 03, 2022 8:12AM ET
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I am short Nasdaq (SQQQ) Dow (SDOW) Russel (TZA) US real estate (DRV) semiconductors (SOSX) EUROPE (EPV) China (WANG) and volatility (UVXY)
John Hill
John Hill Oct 02, 2022 10:52PM ET
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"just wait for the "demand recovery...". Somebody hasn't told this analyst out the world is going to go into a deep recession if not a depression. that doesn't mean world won't go up on supply cuts but it's sure not going to be from demand.
Rekha nayak
Rekha nayak Oct 02, 2022 7:11PM ET
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Yes crude oil could touch 90 dollar.
Joeri Willems
Jurinho Oct 02, 2022 7:00PM ET
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a dramatic economic recession IS near David. Markets tend to have that partially set in the price before it happens. maybe oil is on near term a bit oversold, on a 1-2y horizon it will go back to 50s at least.
Ryan Haycock
Ryan Haycock Oct 02, 2022 7:00PM ET
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The worst (or best, depending on your perspective) thing for long term oil prices right now would be for a recession. the space is already under invested and a recession would compound that. want a catalyst for stagflation? It can be oil. Currently, it looks like the space to be invested in both short and long term.
jason xx
jason xx Oct 02, 2022 1:32PM ET
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If i am a long term investor who believes in LNG long term but not oil what position do i take to take advantage of short term oil and lng prices rising but wont be afraid to cut it at the peak? Investing for a Dividend doesn't make sense if i think oil will not hold up long term. something like CTRA may be great for a couple years but eventually the oil losses will probably ruin the NG gains? Its hard to find a company long term that won't be effected by this eventual divergence.
Warm Camp
Warm Camp Oct 02, 2022 1:32PM ET
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Consider reading more about Alpine High, owned by APA, and see what you get from the reading.
Brad Albright
Brad Albright Oct 02, 2022 1:32PM ET
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@jason. Not an unrealistic expectation, but oil companies are investing heavily in green energy -- their dividends may hold up.
Warm Camp
Warm Camp Oct 02, 2022 10:54AM ET
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Once US midterm elections are over, SPR releases stop, and oil price goes to triple digits. A simple and the likeliest scenario.
Show previous replies (1)
Warm Camp
Warm Camp Oct 02, 2022 10:54AM ET
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jason xx  Fast-tracking clean energy will only make oil more valuable, because “clean energy” does not produce enough energy to run this world. Simple fact of life. On the other hand, this push curtails investment in new oil development and, accordingly, it makes present oil assets very valuable. Btw, are you aware of Chinese numbers showing steady increases in oil and coal production and consumption every year, up to date?
Kris Jay
Kris Jay Oct 02, 2022 10:54AM ET
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jason xx  green energy is a strong push from China to be the sole supplier of solar panels, electric motors with neodymium, cobalt, batteries with lithium,  wind mills, all while causing the US to stumble and not invest in fossil fuels - leaving fossil fuels to China to power its economy, growth and military.     its the silliest thinng to even remotely consider removing fossil fuels when there is no way the alternatives suggested to date are viable to run an economy of our size.   Sure, a few people in CA can commute with an electric car but that's not going to change how we create concrete, smelt iron and steel, dig, build, transport, etc etc.
Warm Camp
Warm Camp Oct 02, 2022 10:54AM ET
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Kris Jay  Yes, China shows “clean energy” carrot to Western fools, while increasing energy production from reliable, efficient sources. It makes their economy more competitive.
Brad Albright
Brad Albright Oct 02, 2022 10:54AM ET
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@warm camp. Your opinions are frozen in time. Of course green technologies do not produce enough energy to power today's world. But commenters here, and the world around you, are wisely anticipating a future shaped by green innovation -- even your beloved oil companies are betting on it. Insisting something will never be because it hasn't been born into complete existence at the snap of a finger is, to put it politely, short sighted. (All bets are off if you're simply gainsaying in service of some political ideology, in which case: Zzzzzzzzzz.)
Warm Camp
Warm Camp Oct 02, 2022 10:54AM ET
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Brad Albright  Talking politely is clearly beyond your capability. Regarding energy issues, I worked in electrical engineering for long time and know real issues there. On the contrary, your messages around show little knowledge about anything related to engineering that you try to hide behind green-woke political jargon.
Mark McMillan
Mark McMillan Oct 02, 2022 9:13AM ET
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Dylan it's good to see an opinion I agree with. I had only seen negative oil articles from Brian on investing articles.
jason xx
jason xx Oct 02, 2022 9:13AM ET
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Hard to be negative on oil in the short term with winter coming. This will be the last winter countries are buying oil at the end of a gun.
Charles schachle
Charles schachle Oct 02, 2022 9:06AM ET
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big gains coming, Dylan if one knows the facts as you presented them in your article. thanks
Steven Angelo
Steven Angelo Oct 02, 2022 9:04AM ET
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I live in Las Vegas, NV. In the last 48 hours our gasoline prices went up 80 cents per gallon, as high as $5.66/gal at Chevron, Shell, Exxon, etc. Smith’s (Kroger super market chain) still holding price at $4.99/gal.
Steven Angelo
Steven Angelo Oct 02, 2022 9:04AM ET
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these prices are for Regular, 87 octane. Some stations charge a dime less/gal for cash
Max Rochester
Max Rochester Oct 02, 2022 9:04AM ET
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oil going to 60
Mark McMillan
Mark McMillan Oct 02, 2022 9:04AM ET
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your nuts!
 
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