Oil production is now suffering from the long Covid
If we look at the evolution of the price of oil over the past three months, we see parallels with the stock market in Germany. The graph shows highs and lows. “Yes, the market looks disoriented, but there are good reasons for that,” says Maximilian Uleer, capital markets strategist at Deutsche Bank Research. And the reasons are to be found in the Covid 19 pandemic. “OPEC members had extremely high spare capacity during the pandemic because production quotas were reduced considerably.” The flip side: “There was little incentive to invest in new production facilities,” says Uleer.
And this is precisely what is currently hitting the oil-producing countries. “Production is running at full capacity, and that’s about the maximum,” says Ludwig Kemper, commodity expert at Berenberg. Admittedly, the OPEC cartel has raised production quotas to pre-Corona levels. “But the additional production of 1.6 million barrels (1 barrel = 159 liters) per day since the beginning of the year by the main OPEC countries is only on paper. Maybe more / less half came to market,” Kemper said. Futures prices show how tight the supply situation is currently. “Oil for next month delivery is currently $107, but for next year delivery it’s only $89,” Kemper said. “OPEC+ is meeting next week to decide on September production levels. So far, OPEC+ is well behind their planned oil production. That’s why I can imagine they will raise again production targets, even if they reversed the May 2020 cuts on paper.” says Carsten Fritsch, commodities analyst at Commerzbank.
“Countries like Saudi Arabia could still increase their production, but they don’t have much interest in doing so. Otherwise, the buffers needed in the event of a well failure would completely melt,” the analyst said. Berenberg Kemper. An assessment certainly shared by Uleer: “The members of the former OPEC are not the countries which bring us the most volumes of oil.” And Russia, which currently sells most of its oil to China and India due to European Union sanctions, cannot increase production either, Uleer believes. “There may be a shortage of parts to maintain Russian production facilities.” A consequence of the sanctions against the country following its war of aggression against Ukraine. The discount of Russian oil to the price of Brent from the North Sea currently stands at just over $30 a barrel.
Extremely low inventories are also weighing on supply, as Kemper points out: “The United States has significantly reduced its strategic reserves in recent months. They are at the level of the 80s”. Inventories are also extremely low in other respects, he adds. And the United States, as an oil-producing country itself, has yet to reach pre-pandemic levels in its production, according to Uleer. “If you just look at supply, crude oil should be much more expensive,” says Deutsche Bank Research’s capital markets strategist. How much more expensive, he leaves open. Because as tight as the supply is, the situation is more relaxed on the demand side. Berenberg commodities specialist Kemper sees Europe in recession at the end of this year, then the United States next year. An assessment shared by Uleer. Moreover, he already expects a technical recession in the United States. The first estimate of economic growth in the second quarter will be released on Thursday. For Europe in particular, such a US slowdown would be good, at least in terms of oil prices. After all, weak economic performance is dampening demand and therefore price. Especially since oil is paid for in dollars and the euro is as weak against the American currency as it has been for two decades.
The geopolitical situation, on the other hand, no longer influences the price of oil. “The risk premia that were still priced in at the start of the war in Ukraine are once again exhausted. The price of oil follows the fundamentals,” says Uleer. And the war of nerves over Russia’s gas supply to Europe is also having a very limited impact on oil prices, according to the Beerenberg analyst. “The argument that oil replaces gas keeps coming up. In practice, however, it is not so simple, and moreover, the conversion of power plants does not happen overnight. Moreover, the quantity additional oil for gas substitution is very low globally,” Uler said. So he too does not see the price of oil exploding, but rather around 110 dollars a barrel by the end of the year, and therefore barely higher than today.
Photo by Ellie Meh