Will There Be a Run in Crude Prices Later This Year?

The two major forces that affect pricing in all commodities are supply and demand—but what may seem like simple economics becomes more complicated when you factor in the impact of monetary policy and geopolitical events.

In most of 2021 and 2022, the oil and natural gas markets became undersupplied after the U.S. and other countries re-opened from COVID-19 shutdowns, and negative prices in crude led to decreased production and delayed drilling programs.

But that undersupply proved temporary.

China’s issuance of another complete COVID shutdown in January 2022 drastically changed the oil market back to an oversupplied environment. This oversupply in turn took crude prices from the $100 area in June 2022 to the $60 area in March 2023, a month after China began reopening.

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Furthermore, the ongoing Russian/Ukraine war has impacted supplies less than what was anticipated. While certainly it has been a factor, it’s not as much of a driving force because Russian crude is still being produced and sold to most of Asia. Currently, as of this writing, crude inventories in the U.S. are sitting at 34 MMbbl above the five-year average. However, gasoline inventories are 9 MMbbl below the five-year average and distillates (diesel) are over 11 MMbbl below the five-year average.

Inflation and interest rates

Meanwhile, the U.S. is still experiencing the impact of the Federal Reserve drastically increasing the M1 money supply (liquid spendable funds) to mitigate the pandemic’s destruction of the economy. The influx of money drove year-over-year inflation to a four-decade high of 9.1% in June 2022. Although that figure has come down somewhat, it’s still three times the Fed’s target, making it no wonder that inflation now has taken front-and-center attention.

Another related issue is, of course, interest rates. To combat persistent inflation, the Fed has raised the Federal Funds rate from near-zero to a range of 4.75% to 5%, as of the March Federal Open Market Committee meeting. Both inflation and rising interest rates take discretionary dollars from the consumer, which can impact demand for energy. Meanwhile, inflation and rising rates also impact the energy market directly by rising costs. It’s no secret that everything from borrowing money to the costs of supplies and moving those supplies all have become more expensive. 

Supply and demand

So far, while U.S. and world production have recovered, so has demand—and it likely will be primary driver in the months ahead.  Barring a U.S and or global recession, fuel demand looks to be rising mostly from China. That could change if COVID surges again in Asia; however, even if it does, China probably won’t lockdown as extensively as it has done in the past.

And what about supply?

Given the latest turmoil in the financial services industry, one major concern will be tightened lending practices, which will most likely impact the oil patch. Tighter lending usually equates to less drilling, which means less production.

Additionally, the shale production in most areas is nearing a peak—with most analysts anticipating this peak to come as soon as 2024 or 2025. Meanwhile, newer discoveries are seeing steeper depletion curves. OPEC+ also has nine of its participants underperforming current quotas.

Yet even with these questions concerning supply, the major key to prices will be global demand, meaning higher interest rates and inflation will remain a threat. That said, a steep pick-up in Asian demand and a U.S. economy that even just holds steady will mean that crude and fuel prices have the potential for another late 2023-2024 run in prices, as production and refining capacity lag.

Dennis Kissler, senior vice president of Trading for BOK Financial Securities, spent 12 years on the CME trading floor as an independent floor trader, owned a major commodities brokerage firm with offices in six states, and worked college summers on an oil and gas drilling rig in western Oklahoma to hone his knowledge of the oil and gas trading industry.

Kissler has worked at BOKFS for over 15 years and specializes in analytical research and trading crude oil and natural gas futures and derivatives. He has over 25 years’ experience in Risk Management through hedging techniques that minimize price risk for energy and agriculture producers and end users.