The Oil Price Rally Shows No Sign Of Slowing
- With the return of Chinese demand hanging over oil markets, analysts are becoming increasingly bullish.
- Gasoline prices have hit their highest level ever and there are no signs of that rally slowing.
- In an effort to cool the oil price rally, OPEC+ increased its production quota, a move that resulted in renewed fears of falling spare capacity.
The U.S. national average for gasoline hit $5 per gallon last week, the highest ever. Brent crude is trading at $120 per barrel and is unlikely to subside much further as China comes back in full force. And according to the UAE's Energy Minister, we haven't even reached the peak—or anywhere near it.
"I've never seen this combination of circumstances in my career over the last 50 years," Gary Ross, manager at Black Gold Investors, a hedge fund, told Bloomberg last week. "The world has very little spare capacity, the economy is strong outside of China, China is now coming back and we're in the midst of a global oil interruption."
The world's shrinking spare capacity has recently come into the spotlight after OPEC+ decided to increase their production targets for July and August in a bid to quench worry about runaway energy inflation.
Yet the decision on paper may never translate into action with just a handful of OPEC+ members having the spare capacity to boost production meaningfully, and according to analysts, they might not be willing to tap their spare capacity as this would reduce the available capacity cushion further, making producers less flexible in case of a production outage such as those that regularly plague Libya, for example.
Meanwhile, demand for oil remains robust, lending additional upward potential to prices, with industry observers and analysts expecting much higher prices before their level starts to affect demand.
"If we continue consuming, with the pace of consumption we have we are nowhere near the peak, because China is not back yet," the UAE's Energy Minister Suhail Al-Mazrouei said last week, as quoted by Bloomberg. "China will come with more consumption."
Indeed, China is expected to soon return to normal, despite news of an "explosive" new Covid outbreak in Shanghai. The outbreak has prompted mass testing in a Beijing district, but it remains to be seen whether the outbreak will spread enough to necessitate a lockdown per China's zero-tolerance policy toward Covid and affect the economy of the Asian powerhouse. If it doesn't, the summer will be painful at the pump and at any shop that sells goods transported by truck.
"We are at $120 without China, so when China comes back, oil is going to go higher," Amrita Sen, chief oil analyst at Energy, said recently, also quoted by Bloomberg.
"Even with high prices, demand is continuing because people, they want to travel, they want to get out. And the second thing is that governments around the world are subsidizing prices," Sen noted.
The subsidy approach that many governments adopted to fight soaring energy prices has been criticized by many on the grounds that instead of discouraging greater fuel use, which would eventually weigh on prices, subsidies, in fact, encourage more fuel use, hence helping keep prices higher.
Meanwhile, the latest about OPEC+ production is not particularly encouraging either. A Platts survey suggested that the extended cartel had once again fallen well short of its production target in May after OPEC alone produced 2.7 million bpd less than agreed in April. Nigeria's production is at the lowest since Platts has been doing the surveys, and Libya just said it was losing 1.1 million bpd in production daily due to continued fighting.
"With only a handful of ... OPEC+ participants with spare capacity, we expect the increase in OPEC+ output to be about 160,000 barrels per day in July and 170,000 bpd in August," JP Morgan analysts wrote in a note last week, reinforcing the grim outlook for oil prices during the northern hemisphere summer when demand rises on increased travel.
The energy minister of Saudi Arabia has been saying for a while now that it is underinvestment which is to blame for the current oil price situation. Refinery shutdowns have also contributed to the undersupply of fuels when demand is on a strong rise, and, of course, sanctions against Russia have not exactly helped.
According to Bloomberg, the supply situation at the moment is so tight that even if Saudi Arabia and the UAE both deploy their spare capacity, it would not be enough to offset the Russian supply losses. Virtually no one is forecasting a decline in oil prices this time. But a growing number of analysts and observers are beginning to warn about the possibility of a recession.
As The Financial Times' David Sheppard put it in a recent column, "China is reopening. People are flying again. Demand is going in the wrong direction. All these factors point to rising oil prices until a level is reached that reduces consumption, probably by triggering an economic slowdown large enough to curtail demand. In other words, a recession for many economies."
It is going to be a very hot summer for oil prices. Economies are just as reliant on hydrocarbons now amid the energy transition as they were twenty years ago before the transition had started properly.