Oil market anchors around $70/b, but volatility to return

The oil market is arguably back in a sweet spot. The only shock in the September OPEC+ meeting was how quickly it was wrapped up, demand is now normalizing and balance is being restored. After 18 months of a painful demand narrative, supply risks could soon become a sore point.

Commentators often talk of a Goldilocks price for crude. One that isn’t too high that it quells demand and one that isn’t too low that it disincentivizes production. Listening to some big oil consumers in recent months it was clear that the approach towards $80/b was making them uncomfortable.  At the same time the collapse in prices under Covid hurt US shale and crushed investment in longer-cycle oil projects.

Just look at the US. The Biden administration called on OPEC and its allies to accelerate their plan to raise production with domestic gasoline prices above the key $3 a gallon level. But at the same time investment from Big Oil has dried up and US production is 2 million b/d below its pre-pandemic peak, raising alarm bells over future supply.

It is no wonder OPEC ignored those White House calls and agreed to continue raising output by its stated 400,000 b/d in October in record time. The 23-country OPEC+ group had previously agreed to increase output by 400,000 b/d each month from August to December. Much of the evidence points to a relative comfort zone with prices hovering around $70/b for the benchmark Dated Brent for the foreseeable future, with demand rises met by additional OPEC barrels.

Global mobility trends, a barometer for oil demand, suggest an upward trend. Even with Covid concerns creating recent jitters in big consumers like China and US, the impact appears to be diminishing as the global economy recovers.

“Global oil demand continues to normalize; Covid-related headwinds are counterbalanced by potential gas-to-oil switching later this year,” S&P Global Platts Analytics said in recent research.

Rocketing gas prices have already curbed consumption in some sectors in China and there is a growing risk of some substitution of gas for oil across the globe as the fourth quarter approaches. 

The S&P Global Platts JKM, the benchmark for Asian spot LNG prices, was assessed at $19.66/MMBtu Sept. 1, rebounding from an August low of $15.30/MMBtu. At this time in 2020, LNG prices were in the mid-single digits.

Market Balances

A reduction in global crude stocks has helped support the rise in oil prices through 2021 but there is still plenty of oil swashing around the market even with the Hurricane Ida disruption still to be fully totted up.

Data from the EIA showed US crude inventories fell by 7.2 million barrels to 425.4 million barrels for the week ended Aug. 27, bringing stocks to about 6% below the five-year seasonal average. However, the drop-off in crude stocks was offset by a 1.3 million barrel rise in gasoline inventories, which now sit at 227.2 million barrels, around 2% below the five-year seasonal average. 

But not everyone buys the five-year average as a useful yardstick for market balances and there is good reason to believe there is still a surplus.

“The five-year average is meaningless. Focusing only on the decline in crude oil inventories is a bad reason to be bullish on oil,” said independent oil consultant Anas Al-Hajji, noting there is still a high amount of forward cover of consumption in the OECD.

And with demand tempered for now with refinery maintenance season in October, any potential market deficit again may have to wait until the end of the year at the earliest.

Supply volatility

On the eve of the two-year anniversary of the attack on Saudi Arabia’s Abqaiq oil facilities, seen as the central nervous system of the oil system, it is once again supply uncertainties that cast a lugubrious shadow.

Iran is the oil market’s swing factor. Prior to the reimposition of US sanctions in 2018, Iran produced as much as 3.9 million b/d of crude, about 1.4 million b/d higher than now.

Talks with the US and other signatories of the Iran nuclear deal have stalled since June and a restart does not appear imminent.

Platts Analytics notes that “supply risks to the downside suggest the potential for tighter stocks,” should additional Iranian barrels fail to materialize.

There are a number of other supply risks that are also flying a little under the radar given the adequacy of available crude in the market.

A tug of war to control Libya’s oil sector has resurfaced, with the row between Libya’s oil ministry and the state-owned National Oil Corporation threatening the 1.2 million b/d in output from the North African country.

Meanwhile, Hurricane Ida in the US has revived memories of the 2005-hurricane shock in the US which caused the release of emergency oil stocks. In recent history hurricanes have been an unsettling feature of the US landscape especially at this time of the year.

Finally, a rise in a number of low-level attacks across the Middle East this year has largely gone ignored due to the lack of impact but should remain a warning sign if stocks and spare capacity diminish.

There is relative calm in the oil markets, but the question remains as to whether another literal or metaphorical storm is brewing.

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London-based Paul Hickin is director at S&P Global Platts. Views are his own.