Energy: signs of demand destruction? Do they outstrip supply risks?

at the start of July I spoke to CNBC Asia about the oil, products and natural gas balances. While there are starting to be some signs of demand destruction, especially in the US where gasoline demand is softening compared to 2021, demand is still near historic highs. Moreover other issues including how to manage the “cut Russia’s revenues, not volumes” remain to be sorted out. Watch at the link .

I told the anchors that we were unlikely to stay stuck in the recent 110-120 range, implying the breakout could be in either direction. Since our discussion around the Asia market open on July 4, market prices have fallen well below that range and are currently well below $100/barrel. Product spreads too have collapsed perhaps due to increased production in Asian refiners including China and India, the former remains some of the key swing refiners. Drivers of the decline include the realization that China’s covid zero policy is far from over, the switch from worries about EU insurance ban on seaborne crude to a near-term effort to weaken Russian oil revenues – and broader view that current policies bought time ahead of any implementation. Still, many of these issues including limited surplus capacity in OPEC+ countries and dealing with the push away from Russian fuel have yet to be addressed. The drop in prices is welcome for global consumers – and many politicians but likely only reinforces the cautious stance of many oil producers, in the Gulf, in the US oil patch and more.

On the natural gas side, buyers in Europe, especially Germany, are scrambling to plan for the winter. While storage is higher than in 2021 (when Russia was reluctant to fill up Gazprom storages in Russia and only provided the existing volumes), there are real concerns for the winter. Moreover the costly imports of LNG from earlier this year as high prices in Europe drove cargos from Asia to Europe will have to be absorbed. Germany in particular is facing some pressures for a new growth model as it no longer has access to cheap feedstock. While more efficient than many this is a major shock, which remains.

Global oil markets remain tight with limited new supplies and demand remaining relatively robust. There has been a bit of a supply response, especially on the refining side, and some early signs of demand destruction. It will be a little more modest a driving season this year than last in the US – but demand remains much higher than in 2018/19 despite the higher prices. 

  OPEC+ is sticking with plans to gradually add supplies, ignoring both the members that cannot meet their targets in Africa etc and the big question of Russian supplies, and with the few countries with spare capacity adding it sparingly.

 The US goal is now cutting Russian energy revenues by maintaining production and reducing the price for those barrels rather than the EU proposed cutting of volumes which was and is boosting the cost for non-Russian supplies. There remain many questions about the details of this price cap, how far the US and allies will be willing to go to enforce it, likely using a combination of EU extraterritorial insurance and financing restrictions and US secondary sanction threats.

 Inherent uncertainty in that as achieving that goal puts considerable power and decision making authority in the hands of both Russia but also major Emerging market buyers of crude oil. The latter, China, India, Turkey and others have some alignment with the consumers and politicians of the G7 who want to cut Russian revenues – they all want cheaper oil prices, but they may prefer more leverage in negotiating directly with Russia or hedging their bets. This suggests that a move towards the price cap and insurance bans will be subject to volatility, hitting not just global consumers but also producers and reducing transparency in pricing.

 Meanwhile these market conditions increase the economic case if not fully the political case for a deal with Iran and perhaps Venezuela – and limiting the development of an economic isolation group among oil producers. Both Iran and the US see the benefits of a deal and are unwilling to call time on the talks, which would necessitate tighter sanctions enforcement – and even tighter global markets, but domestic politics intrudes.

 Longer-term investment across other fossil fuel production such as natural gas is picking up apace – with the US, Qatar and other producers announcing new production for the coming years, but not this year. EU buyers are somewhat hamstrung tho, buying more short-term LNG on the spotmarket, preparing to ration supplies, but uncertain about signing the 20 year plus agreements producers are demanding due to questions about the balance between different elements of energy security. Overall, this winter could be an expensive one for European and Asian buyers. High prices reduced incremental purchases from Asian buyers after strong demand in 2021. This will not be possible next year, suggesting that major buyers will face greater bills. 

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