We have been moving strongly in the key crude oil benchmarks WTI and Brent over the past few months. It was initiated by the arrival of positive news on the Covid front that the vaccines in development were extremely effective, promising an endpoint for the spread of the virus. This upward trend in crude oil was amplified by the gradual decline in U.S. shale production and stocks during the same period.
Data EIA, chart by author
Finally, the move in early January, by OPEC + to limit production to mid-2021, and an extra “gift” from Saudi Arabia to remove another 1 million BOPD from the market, gave the impetus for WTI to firmly to rise in the $ 50s. . In this article, we discuss the main reasons why we think the rising trend for crude oil will continue this year. Why?
The question will return
Despite the current closures hampering demand, the trend is higher. As vaccination of the vaccines increases the pool of the virus-immune population, business activities will resume, creating demand for refined petroleum products. In the chart below, the EIAs, the Energy Information Agency, are forecasting the trend for refined products over the next few years. For gasoline, the primary motor fuel used in the U.S. will gradually move higher in the second half of 2021 and then moderate in 2022, just below the levels of 2019. The EIA makes some assumptions about work from home and reduces the commute in this prediction. The forecast is not as robust for aviation fuels, showing a slight growth in 2021, but a return to near 2019 levels in 2022. Total demand will rise slightly higher until 2019 than 2019. Related: The pandemic could lead to a large oil supply
It is strong for oil prices.
The political and macro environment will lower stocks
Elections have consequences. The concentration of power over the next few years, with Democrats controlling all three branches of government, will make the increase in U.S. production very unlikely. From recent highs in 2020 where the US produced more than 13 mm BOPD, production has fallen to 11.0 mm BOPD in response to low prices. We will see an improved and stricter regulatory environment in the coming years. The US will definitely be placed on a path where renewable fuels are increased at the expense of petroleum-based fuels. The expected accession of the USA to the climate agreements in Paris will only exacerbate this trend. Fossil fuels will become scarcer, and this is favorable for prices.
OPEC + surprised the world with its intention to eventually raise prices higher. Saudi Arabia has used its power as one of the world’s three largest producers of crude oil and its undisputed position as the world’s cheapest producer, unilaterally choosing to withdraw another 1 million BOPD from world markets outside its OPEC + – responsibilities. This was the action that moved the oil markets above $ 50 for the first time since early March 2020. This strongly suggests that the cartel is resuming its traditional role of fixing crude prices for the world.
The decline in US inventories will firmly return price power to OPEC +. The newly acquired $ 50 handle will likely be a floor price going forward. The abundance we have been dealing with over the past few years will continue to disappear as capital controls by US shale producers keep the overall trend. OPEC + actually has only one mission to provide the maximum return for its members by balancing supply and demand. The current infatuation with Western economies over climate change is less of a motivation for the key countries that make up OPEC +. Their economies are mainly driven by crude oil exports, and they all want higher prices.
OPEC + to resume the role of swing producers is strong for oil prices.
Commodity prices will rise
Last fall I had a Oil price article where I thought there might be a commodity tree on the horizon. There is no commodity that is more fundamental to the world economy than crude oil. Among the things that drive crude oil other than scarcity is the fact that it is priced in dollars, which makes it very susceptible to inflationary pressures.
MarketWatch
The dollar index has fallen over the past year, but has recently seen support with a week-long trend. A stronger dollar is better for oil prices because you get less oil for the dollar, which means you have to spend more of it to get the same amount. It is inflationary and as mentioned above, crude oil is very susceptible to this pressure.
Related: Saudi Arabia launches new bulls in Middle East oil
Nor can we ignore the amount of stimulus that the world economy has unleashed in response to the virus. We think if the infection rate starts to fall, governments will start addressing the historically low interest rates that helped provide liquidity in the pandemic. There is a price to be paid for the tidal wave of cash distributed so far, and the further stimulus to come as the Biden government takes control of the economy. Classical monetary theory tells us that part of the price is likely to be inflation.
There is a temptation to compare this crisis with the financial crisis of 2008. The Treasury has borrowed about $ 500 billion to provide the liquidity that prevented the collapse of the financial system. So far in the U.S. alone, nearly $ 4 billion in stimulus has been granted, with other actions taken by the Federal Reserve to ensure that institutions, corporations and small businesses have the necessary funds to operate. As previously noted, the Biden administration is just getting started and has discussed trillions more in financial stimulus for the economy.
Marketwatch
Commodity prices rose sharply between 2008-2011 in light of the stimulus provided in response to the 2008 financial crisis. The same index below shows that the index has risen sharply over the past six months. This increase is certainly related to the amount of stimulus that is expected to be provided by the world economy.
Marketwatch
As noted earlier in this article, crude oil is the most fundamental and volatile product.
A rising or sharply rising price environment for commodities is strongly bullish for higher oil prices.
Your takeaway
Brevity refrains from discussing all the factors that could affect oil prices in the short term. With the information provided in this article, we believe that there is a strong argument for a continued moderate rise in oil prices for the rest of this year.
We expect a rise in crude prices in the long run, because the shrinking stock cannot meet the rising demand. We consider it inevitable, as I noted earlier Oil price article. Underinvestment by major international oil companies over the past six years will create a scenario where the industry simply cannot respond in time to the increased demand.
By David Messler for Oilprice.com
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