Oil prices may not have as wide a swing in 2023 as they had in 2022, but the market will still remain volatile and risks price shocks as much from economic developments as geopolitical ones, energy analysts say. One of the biggest wild cards for markets in general is the economic reopening of China as it relaxes its “zero-Covid” restrictions. That could drive crude prices higher if demand increases significantly. The continued ripple effects of Russia’s war in Ukraine could also continue to put upward pressure on prices if it constrains global supply. But counterbalancing that is the threat of recession in the U.S., which could further reduce already weakened fuel demand. China could also become a drag on prices if its reopening fails, or if it backtracks as record high Covid cases take hold. “I think we’re going to have a range again. The high water mark will come early in the first quarter,” said John Kilduff, partner with Again Capital. “I’m expecting we get over $90 [a barrel], but there’s economic concerns. … There’s a hopeful analysis that we’ll be spared the high prices of this year. It’s not unrealistic, but from a consumer perspective, we’ve got to be lucky.” Keeping a lid on prices Oil futures fell Wednesday amid signs that China is moving ahead to normalize its economy, with the removal of border and travel restrictions. As of Jan. 8, China will stop requiring travelers to the country to quarantine upon arrival. The price of Brent, the international benchmark, was near $84 a barrel, after trading as low as about $75 a barrel earlier this month. That was the low end of the 2022 range, which included a spike to $133 per barrel in March, shortly after Russia invaded Ukraine in late February. West Texas Intermediate crude futures were just under $79 per barrel. Citigroup’s Ed Morse was one of the more prescient forecasters for 2022, expecting weakening demand to keep a lid on prices as others anticipated the risk from Russia continuing to drive crude sharply higher all year. In early December, Citi forecast first-quarter 2023 Brent prices would average $83 per barrel, and predicted that by the fourth quarter next year, the average would fall to $76 per barrel. “I think as we thought about 2022, we think that the year’s going to end at a lower price than the beginning of the year,” said Morse, Citigroup’s global head of commodities research. “I think the first quarter might well be tighter than the fourth quarter, but we see more supply coming into the market than demand.” Morse said he expects demand will grow by 1.3 million barrels a day globally, but sees supply growing at about 2.7 million barrels a day. For U.S. consumers, the roller-coaster ride in oil prices this year is ending with a national average price of $3.13 per gallon of unleaded gasoline, which is less at the pump than $3.28 per gallon at this time last year, according to AAA. Gasoline prices hit a record high of $5.01 per gallon in mid-June. Dan Yergin, vice chairman of S & P Global, said his base case is that Brent will average about $90 a barrel in 2023, and the biggest driver of the price could be economic. “If we have a weaker economy, slower economy or recession, then prices are definitely going to go down,” he said. “I think GDP wins out in the end. The upside would be the underinvestment case, just not enough investment, then demand recovers and there isn’t the capacity.” Russia’s invasion of Ukraine was the biggest shock to the oil market in the past year, sending prices spiking in the first quarter. But analysts say other factors will be at play in 2023. The overriding question is how fast will China reopen and will it be able to sustain a reopening with changes. Yergin said. Under some scenarios, a strong reopening in China could drive oil close to about $120 if supply is short. Another is whether Russia decides to cut back on production, as it has threatened, and a third is how much the tightening by global central banks squashes global growth. In a low- or no-growth scenario, oil could be back to the low $70s per barrel, he said. “It really depends on what is in the minds of three people — [Fed Chairman] Jerome Powell, Vladimir Putin and Xi Jinping,” said Yergin. Production at issue The other factor will be whether OPEC+, which cut production this year, continues to hold down output or adds more oil to the market if demand picks up. The Organization of the Petroleum Exporting Countries, plus Russia and other partners, next meets in early February. “There are many pressures at work,” Citigroup’s Morse said. “I actually don’t think there’s anyone on the planet that knows what they’e going to do in February. They are aware of uncertainties. They are aware of the pressures. The UAE had made it fairly public that they are not happy with the cuts, and it’s not clear to me that they won’t be more firm about it the next time around, if they are pushed by their larger neighbor to make another cut.” OPEC leader Saudi Arabia pushed for the reduction of 2 million barrels a day in production, which OPEC+ agreed to in October. Even so, prices weakened as investors worried more about soft demand from China and recession in the U.S. than the elimination of barrels from the market. “The Saudis have received the largest revenue they ever received in any year in their history,” Morse said. “Yes they have a large appetite to spend, but we think their fiscal break evens, given where we see prices and current production is in the low $60 range. So we don’t see any compelling reason from a domestic market perspective for them to want to balance the market, so to speak, or to put a floor under prices, more accurately.” Morse said there already is a floor under prices, with the U.S. government having committed to buying back oil for the Strategic Petroleum Reserve at $70 a barrel. The U.S. has released 180 million barrels from the SPR this year to stabilize the market as Russian energy was sanctioned. The latest efforts to penalize Russia were Europe’s ban on seaborne oil, as of Dec. 5, as well as a G-7 price cap on the price Russia can receive for its oil. Last week, Russia’s deputy prime minister said the country may cut oil output by 5% to 7% , due to price caps, and it may end sales to countries that favor the caps. Where Russia fits in Morse said Russia, one of the top three global producers along with the U.S. and Saudi Arabia, may have changed forever as a central figure in global energy markets, and the country could be less of a wild card than it was in the past year. “We think that Russia will never emerge as an energy superpower again,” said Morse. “Never is a hard word to use, but not in a decade will it be an energy superpower because of the absolute inability to sell the amount of natural gas that they could produce because of the lack of people who want to buy it in the right place.” He said it would be too expensive for Russia to build pipelines to other customers, beyond Europe. Russia is also spending a lot to find ways around sanctions by securing “dark” tankers to ship its crude to buyers in Asia. China and India remain its biggest customers. Morse said more oil supply is coming on line from the U.S. and other Western Hemisphere producers in 2023. He expects a combined 1.2 million barrels a day to come on line from the U.S., Brazil and Canada. He also expects additional barrels from Guyana, Venezuela, Argentina, Colombia and possibly Mexico. OPEC+ could add another 500,000 million barrels, with countries like Iraq and Libya increasing exports, he said. Analysts also said they are keeping an eye on Iran, which has been sanctioned for its nuclear program. Anti-government protests have been underway for several months. “They’re another source of supply potential … we’ll be watching how these protests pan out,” Kilduff said. “If there is a chance for regime change there, it would potentially open the country’s oil supplies back up to the global market.” Demand wanes As this new oil flows into the market, there are big questions on the demand side. China’s demand has been weak, but it could increase by 700,000 barrels a day in 2023 as it reopens, Kilduff said. “Europe [demand] is down by several 100,000 barrels a day on the demand side, and the U.S., according to four week moving average, is down on major products,” he said. “If you have the three largest economies in the world not having a bullish impact on the market, where is the demand coming from?” Kilduff asked. According to the U.S. Energy Information Administration, U.S. consumers used 8.7 million barrels a day of gasoline in the week ended Dec. 16. The four-week average is 8.4 million barrels, down 7.1% from a year ago. “We have low gasoline and low diesel demand both,” Morse said. “The low [U.S.] gasoline demand started in March and April, when it really went down to the lowest level in the last five years other than 2020, the pandemic year.” Morse said some of the decline, on the margin, might stem from the increase in electric vehicles, but more likely results from more efficient traditional vehicles and a change in consumer behavior and demographics. “Survey data indicated people decided to shop less and go to restaurants less by car. We know summer driving season was nothing compared to where it had been forecast to be,” he said. “We have a couple of other things at work.” Chief among them: “A pending recession.”
© heardonwallstreet.com