Paisie: Global, Domestic Uncertainty Weigh on Oil Prices

John Paisie is president of Stratas Advisors, a global research and consulting firm that provides analysis across the oil and gas value chain. He is based in Houston. 

Oil prices remain well below the $120 level that was reached in June 2022 after the start of the Russia-Ukraine conflict and the subsequent sanctions that were placed on Russia oil exports. While the sanctions have been expanded, including a price cap on Russian crude oil and refined products, the resulting impact of the sanctions has been on the trade flows and the price that Russia received for its oil exports, with little impact on export volumes.

The announcement at the beginning of April of additional OPEC+ supply cuts of 1.16 million bbl/d starting in May gave a short-term boost, but oil prices are now back on a downward trend. One major factor has been concern about the regional banking sector in the U.S., with First Republic Bank becoming the third large regional bank to fail, and PacWest emerging as the next bank under severe pressure. Another factor is the concern associated with the impending U.S. debt limit, with the U.S. Treasury Department saying the government will soon run out of money. Oil prices are also not being helped by the ongoing releases from the Strategic Petroleum Reserve (SPR), which have been averaging 1.5 MMbbl during the last six weeks.

There are other factors that are weighing down oil prices, including:

• China’s moderate growth since the removal of the zero-COVID policies, especially with respect to its manufacturing sector, which is being negatively affected by the weakness in export markets, as indicated by the dropoff in new export orders;

• Besides concerns about the debt limit, recent data about the U.S. economy have been mixed, with core inflation (excluding food and energy) still running well above 5%, coupled with a GDP growth rate of only 1.1% during the first quarter. There are also increasing concerns about consumers, given that the University of Michigan reported that U.S. consumer sentiment decreased by 9.1% in May from April, and that real wages have been declining for 25 consecutive months, while consumer credit card debt levels are reaching new highs with record level interest rates; and  

• The tepid economic growth has translated into weak growth in oil demand, including in the U.S., where gasoline demand is running essentially on par with the previous year and still around 5% less than in the pre-COVID year of 2019.

The oil traders have reinforced the concerns by significantly reducing their net long positions since the bump up that was initiated by the announcement of the additional production cuts by OPEC+. Since mid-April, the trend has been downward with traders adding to their short positions.

Looking forward, we think there is limited risk associated with supply being greater than our forecast, in part because it is our view that OPEC+ will remain proactive in adjusting supply to align with demand. There is little reason for OPEC+ not to do so, given that there is room for oil prices to increase without having a material impact on the greater economy, in addition to the muted response from non-OPEC producers (including U.S. shale).

Gone are the days when OPEC had to worry about losing market share if it cut back on supply. It has been reported that Russia’s exports have not decreased, which is consistent with Stratas Advisors’ view that Russia’s announced cuts in supply stemmed mainly from reduction of domestic refinery crude runs, with crude exports left relatively unchanged. Meanwhile, Africa’s oil production continues to struggle because of internal issues, as highlighted by Nigeria’s production falling below 1 MMbbl/d in April.

Consequently, the price of oil will rest mainly with demand. In our base case we are forecasting that demand will be sufficient, along with the supply cuts, to push the oil market into a deficit. Ultimately, we expect that economic situation in the U.S. will have more clarity with a deal being reached on the debt limit coupled with the regional banking sector stabilizing (in part, because bank deposits are still well above pre-COVID levels) and the Federal Reserve ending its tightening cycle. We are also expecting China’s economy will strengthen somewhat because it has the flexibility to boost economic growth since it is not facing an inflation issue. China’s growth, however, will remain moderate, in part, because of its manufacturing sector, which is being hindered by weakness in its export markets. 

Bottom line: we expect oil prices to zig and zag on an upward trend with a price floor being established at around $70/bbl. Without a supply shock, we do not expect oil prices will break through $100/bbl this year.