Underlying oil market fundamentals – good ol’ supply and demand – are as bullish as they have been over the past decade, says Pavel Molchanov, Managing Director and Energy Analyst for Raymond James Equity Research.
For our readers with investments in the oil value chain, the fact that oil prices reached fourteen-year highs in the early spring of 2022 helps explain the Energy sector’s outperformance year-to-date, building on its gains from 2021, when it had been the best sector in the S&P 500. On the other hand, the oil market rally is also contributing to the global economy’s inflationary spiral, with consumers as well as businesses feeling the pain of high prices at the fuel pump. Whether we like it or not, high oil prices are here to stay. We forecast that West Texas Intermediate (WTI) crude will average $100/barrel (Bbl.) in 2022, with only a modest cool-off to $90/Bbl. in 2023. For some perspective, as recently as December 2021, WTI was in the low $70s. Brent crude, the global benchmark, should remain a few dollars above WTI.
Geopolitics and the oil market
There is no disputing the fact that geopolitical factors played a major role in the oil market rally of recent months. The prime example is the crisis that culminated in Russia’s invasion of Ukraine. Why does this matter for the oil market? Because Russia produces approximately 11 million barrels per day, or 11% of the world’s oil supply – on par with the U.S. and Saudi Arabia – of which7.5 million barrels per day (bpd) is exported, including 4 million bpd that is sold into European countries.
Russia’s natural gas production – three-quarters of which goes to Europe – is even more of a geopolitical hot potato. Thus far during the war, oil and gas pipelines have continued to operate normally. Also thus far, sanctions have had only a peripheral effect on Russia’s energy sector. Germany has made it crystal clear that the Nord Stream 2 gas pipeline – an $11 billion project owned by the Russian gas giant Gazprom – will be blocked from operating for the foreseeable future. The U.S. has imposed an embargo on Russian oil, and the U.K. and Poland plan to do so by year-end 2022, but unless the rest of Europe follows suit, it won’t mean much in practical terms. Separate and distinct from Russia/Ukraine, other geopolitical hotspots that contribute to high oil prices include Libya (the plan to hold a presidential election has broken down); Yemen (the Houthi rebels continue to fire missiles into neighboring countries); and Iran (progress in negotiations toward a new nuclear agreement is uneven, at best).