Filenews 19 July 2024 - by Guarev Sharma
In recent weeks, global crude oil prices have created false expectations among market bulls. Many investors in this category, possibly against the broader perception, do not see the price of $85 a barrel for Brent as a reasonable cap under current market developments for the global benchmark.
Although the buzz about triple-digit prices fell significantly in the second quarter of the year, the new high for the price of crude in the third quarter is placed at $90 per barrel.
This assessment overlooks the fact that Brent crude futures barely managed to hold above $85, and at one point even slipped below $80 after the last OPEC+ meeting. In June, the Russia-led group of oil-producing countries and OPEC, led by Saudi Arabia, they decided to gradually lift some of the additional cuts in their production.
The move gave many short-sellers carte blanche to oversell. But that too didn't last, as Brent futures returned to the familiar range between $80 and $85. So how likely is crude to climb to $90, and how could it get there?
Five factors that can drive prices to $90
There are five factors that combined to potentially push Brent crude to the $90 level. First, we are at that point in the trading cycle where summer demand in the Northern Hemisphere takes center stage. Many are keeping a close eye on seasonal summer demand in the U.S., as well as that of aviation fuel. The picture for aviation fuel is encouraging but the signs are mixed, while expectations of a cut in interest rates by the Federal Reserve may increase the confidence of US consumers, which could lead to an increase in fuel demand.
Second, the weakening dollar, in light of expectations of interest rate cuts, may also boost crude purchases by major emerging markets (EM), which pay for "black gold" in dollars and often dearly when the dollar is stronger against their currencies.
Third, after the sluggish start of the Chinese economy at the beginning of the year, with GDP growth below 5%, many market participants are pinning their hopes on the economic stimulus expected from Beijing after the conclusion of the Third Plenary this week. This development may improve demand for crude and offer support to oil bulls that (so far) have relied only on strong demand from India, from all major importers worldwide.
Fourth, although OPEC+ will gradually ease its additional cuts of 2.2 million barrels per day (bpd), the cartel will continue to keep 3.66 million barrels per day off the market until the end of 2025. Saudi Energy Minister Prince Abdulaziz bin Salman said OPEC+ may freeze the gradual lifting of cuts or even reverse it if demand is not strong enough in the second half of the year.
Fifth and finally, the global geopolitical picture is full of adversity. The war between Israel and Hamas in Gaza is not expected to end anytime soon and continues to fuel other tensions in the region. Such as attacks on merchant ships in the Red Sea by Yemen's Iranian-backed Houthi rebels and ongoing skirmishes between Israel's Israel Defense Forces and Lebanon's Hezbollah, also backed by Iran. The area seems to be on the brink of a cliff and there is a lot of uncertainty. Similarly, the Russia-Ukraine war also continues, with the Ukrainians constantly targeting Russian oil and gas infrastructure.
Five reasons Brent won't see $90
However, all of the above may still not give Brent enough of a boost to reach the $90 ceiling. First of all, it is unlikely that fiscal stimulus in China will match Beijing's economic interventions over the past decade. While they may give oil a boost, it is unlikely that Chinese fiscal stimulus will fully offset the factors weighing on the market.
Second, although OPEC+ has cut production, non-OPEC oil production, especially in the U.S., but also in Canada, Brazil, Norway and Guyana continues at a steady pace. Therefore, it is likely that this year will end with a small surplus of sweet crude oil as well as a small deficit of heavy crude.
Third, higher U.S. crude production not only boosted non-OPEC supply, but drove down crude imports from abroad. This has essentially recalibrated the level of geopolitical risk premia imposed by the market, which is currently nowhere near the level recorded in the transition of the last decade. So far we have seen low single-digit increases in geopolitical risk premiums versus low double-digit increases in the past. Most importantly, so far none of the skirmishes in the Middle East have directly affected oil and gas infrastructure.
Fourth, the market is home to two major producers selling oil at a discount, Iran and Russia, which have been sanctioned by the West, and are finding buyers in two of the biggest crude consumers, India and China. Even if the discount they offer is fictitious of one or two dollars, it nevertheless pushes, to a certain extent, lower prices in the physical market.
Finally, the picture for future demand remains blurred. Perhaps in the summer we will get a better picture. At present, however, the forecasts of OPEC and the International Energy Agency (IEA) for demand developments are diametrically opposed. The IEA estimates it will be below 1 million barrels per day (bpd), while OPEC insists it will likely exceed 2 million barrels per day by the end of the year. But even if demand is at an average level, non-OPEC production can meet it.
Based on the above, weighing both bullish and downward factors and ruling out any significant unexpected macroeconomic reversals and the unlikely possibility that an all-out war will directly affect energy infrastructure, we estimate that Brent futures will likely hover in the $75 and $85 range.
