The long-awaited second half boost in oil prices has arrived, with oil prices getting close to $100/barrel before pulling back. Unfortunately for oil producers, this higher price is a function of supply cuts (largely from the GCC, with Russia belatedly participating) rather than the hoped for Chinese demand surge. While oil demand has been ok, due in part to Chinese stockpiling, and Western recession avoidance, it’s unlikely to pick up as strongly as producers hope. Looking ahead, inventory drawdowns and supply cuts suggest the direction of price travel is upwards, but the demand picture, especially early next year suggests oil might not stay over $100 as price-conscious Asian buyers may temper flows and the local currency cost of oil rises in many countries.
OPEC+: Cuts from GCC/Russia offsetting gains from other sanctioned countries.
On the supply side, the steady increase in oil exports from Iran (at discounted prices), helped to undermine the cuts from other OPEC+ forcing the latter to cut more to tighten the market. Belated support from Russia, in part due to the rise in fuel prices pushing G7 participants out of the market, is also helping to tighten market especially of products like Diesel.
Iranian supplies, pushed on the market via higher tanker rates and helped by a Combo of developed unofficial trade channels and US unwillingness/inability to enforce sanctions, have been a major challenge to other OPEC+ members attempts to tighten markets. By contrast, supplies from Venezuela, have been more constrained with the modest sanctions relief mostly helping to reduce China’s demand share of Venezuelan crude, replacing it with American ones. The recent visit of Maduro to China, while sending a political message, is unlikely to prompt much new investment given the impact of US secondary sanctions and the need for western equipment. Looking ahead, further sanction relief will be reliant on Venezuela making at least some political concessions.
Although the net increases in fuel from sanctioned countries have added supplies, the divergence in policies has a major impact on medium-term projections. The persistence of US sanctions on Iran leaves China with price leverage (as the primary buyer), while limited new investment is possible.
Price-sensitivity: Watch China and India
So far demand from China at least has held up despite a rise in global benchmark prices. In part this reflects their purchasing power as a major buyer of crude from a range of sanctioned countries – and the almost unique buyer for illicit Iranian crude. Some of this demand seems to have gone to fill up China’s petroleum reserve as fuel demand may be overstepping economic actitivity. If so, it’s possible that higher prices may lead to a moderation in purchases as refineries struggle to pass on higher costs.
India, the biggest beneficiary of the oil price cap, which gave it access to somewhat cheaper Russian supplies, is another place to watch. Economic activity is still strong, helped by investment from US and other friends looking to China+1 strategies. However the rising costs may still dampen demand.
Local currency pain
While the political sensitivities of gasoline prices are high in the US, and the Biden administration may be more worried even than the Fed, other countries especially those whose currencies have weakened against the dollar may have the bigger hit. Rising fuel costs in local currency terms could weigh on consumers (as most countries have reduced fuel subsidies) and exacerbate external balances. If we see a reversion to capped prices for refined fuel this will squeeze local refineries and cause distortions. Even though demand destruction may be limited at $100 a barrel, the combo of higher energy costs in local currency is likely to impact demand, especially with EM financing costs also rising. Overall, this suggests 2024 demand is likely to remain softer than OPEC forecasts.
Overall this suggests that supply cuts rather than demand strength will be more meaningful drivers of oil markets. Some additional supplies, including those from the US and Brazil will come to market in the next year, along with the possibility of slightly more Iranian and Venezuelan crude. The prospect of more fuel from African OPEC producers is low.
Ziemba Insights 