Oil & Gas: Oil, not likely to boil!

15 Jan 2024 , 11:38 AM

Vandana Hari (independent oil consultant) expects the Oil markets to remain well supplied. This is because the demand outlook is muted, and OPEC+ has challenges to enforce supply cuts when its spare capacity is at record highs. The risk of a runaway increase in prices is low (US$75-80/bbl); the tightness in refining markets will see moderation, as supply catches up. Such sentiments are well reflected in the net short positions of commodity traders and bode well for India, which has a very high import dependence.

• Sluggish demand outlook: Oil demand in CY24 is likely to be at 103-104mbpd, growing at ~2% — in sync with the long-term average mainly because of the normalisation of demand in key economies, and a weaker-than-expected recovery in China. India, and the African nations, etc., are witnessing strong growth; however, their share in overall consumption is <10%. Moreover, there are divergent views on growth rates for oil consumption. While IEA and EIA are forecasting demand growth of 1-2%, OPEC appears to be even more optimistic with ~3% growth in CY24 — and to that extent — the Energy market clearly lacks consensus on the near-to-medium-term demand growth trajectory. Such issues would weigh heavy while planning demand across the key nations, and impact the pricing.
• OPEC has surplus capacity: In the past 12 months, while OPEC+ has been lowering effective supply in the market — US, Iran, Venezuela, Brazil, Guyana, etc., have ramped up production. This has helped cushion the risk of supply outages. Ramp-up in the US shale supplies, which were not anticipated by markets, have been on the back of productivity gain rather than new drills. Such gains are a bit tricky to track and forecast. As a result, the market seems to have adequate capacity to meet unexpected demand revival. It is estimated that OPEC+ has nearly 4.5-5mbpd of surplus capacity, which is expected to increase further in the next two to three years as Saudi, Kuwait, and others invest to scale up the production capacity.
• Risk of price run-up is low: As the demand outlook remains uncertain, market is relatively oversupplied at a time when OPEC+ has surplus capacity, risk of runaway increase in prices is low; prices may remain range-bound between US$75-80/bbl in the highest confidence level with a downward bias. The risk of run-away increase in prices exists only if: 1) there are massive supply outages on law and order issues. 2) Surprises in demand from the US, EU, and China; which account for ~50% of the overall consumption. 3) OPEC+ successfully reinforcing stringent production cuts, which will eliminate the risk of supply surplus. 4) The ongoing geopolitical conflicts (Russia-Ukraine, Israel-Hamas, etc.) reach a flashpoint and the superpowers intervene, which sets a plot for a much larger conflict, thereby inducing risk premium in prices.
• Will OPEC disintegrate? OPEC+ has attempted to change its strategy from mandatory to voluntary production cuts; it has not worked well. Based on current projections, market may remain well supplied in 1QCY24 with the next OPEC meeting scheduled towards June’24. And to that extent, OPEC+ has to first demonstrate its unity in a market that is oversupplied and then, implement the strategy that may play out in its favour. Meanwhile, what remains unclear is why OPEC+ is proposing production cuts as well as its bullish stance on demand in CY24. If the demand outlook is strong, there is less relevance in cutting production incrementally; such issues may warrant a risk to long-term sustainability of the structure of OPEC+.
• Refining imbalances may subside: GRMs in the past two years have been volatile, on the back of risk of supply disruptions, particularly in HSD, MS, and ATF. Volatility in LNG had forced substitution by HSD in key markets, leading to above-normal spreads. It is estimated that ~4.5mbpd of new refining capacity is set to commission progressively through CY24-27; which should keep markets well supplied. Further, as the LNG prices have subsided from their historic peak, risk of diesel substitution should remain low; which also supports GRMs to converge to long-term avgs. Meanwhile, Asian refiners including India are likely to shift towards Saudi, even with its premium over the Urals, given the strategic transportation advantage.