The main logic of thecurrent oil price change has shifted from geopolitical dominance to a trade-off between the market's geopolitical risk premium and the IEA's loss of reserves and slow demand growth, with markets still in a wide swing period. The upsidewas driven mainly by the long standing premium for low investment, low capacity, low inventories in the oil market, and the geopolitical risks posedby the Russia Ukraine conflict and civil unrest in Libya. The main drivers of the downturn were the global economic downturn, the suppression of demand growth by high oil prices, the stockpiling of US and IEA member states, the progress of domestic outbreaks, the Iran nuclear negotiations, and whether other regions increased their imports of Russian crude oil.
I. Supply side inelasticity remains long term
A steady and substantial increase in output within OPEC is unlikely. In terms of the current global supply of crude oil, surplus capacity is shrinking. As of April, data from Rystad Energy showed that the global crude oil remaining capacity in April was expected to be 6.26million barrels per day, mainly in the hands of Saudi Arabia, Iraq, the United Arab Emirates and Iran. Crude oil production in other countries is essentially operating at full capacity. Starting in May, the OPEC + plans to increase production from 400 thousand barrels per day to 432 thousand barrels per day, but it was difficult to meet expected production as most member states were already operating at full capacity. According to OPEC’s monthly report in April, the compliance rate of OPEC’s production cuts in March was 157%. Due to the internal stability of OPEC and no discordant voices, it is difficult for OPEC to achieve substantial growth on the supply side.
US shale oil still does not have the potential for substantial growth. In terms of US crude oil production, US crude oil production has recently increased to 11.9 million barrels per day. Meanwhile, Biden's government has shifted its approach to the shale oil industry, offering oil and gas companies drilling rights on federal land in at least 8 states in June, helping to boost the US shale oil industry's recovery. The number of rigs also rose to 549 last week, but the growth in rigs is still unable to support growth in US shale oil production due to lower production of new wells in the US. The increase in US shale oil production is mainly due to the consumption of inventory wells, which are still not on a substantial upward potential if the number of rigs does not grow at a faster pace as the number of inventory wells dries up.
Oil prices remain underpinned by geopolitical risks. Now that the conflict between Russia and Ukraine is on a long term course, and sanctions against Russia are escalating in Europeand the United States, the European Union has considered including Russian crude oil in the sanctions, and major global trading companies are planning toreduce their purchases of crude oil and fuel from Russian state owned oil companies in May. Vitol Group, the world's largest independent oil trader, said it plans to stop trading Russian crude oil and oil in full by the end of 2022 and expects Russian production to be reduced by 2.5 million to 4.5 million bpd from May. In addition, the civil strife in Libya has led to a reduction in oilfield production by 550,000 barrels per day. No significant progress hasbeen made in the negotiations on the Iranian nuclear issue. It is still difficult for Iranian crude oil to return to the market in the short term.
II. Demand sidehard to meet expectations
Inflation soared, the dollar exchange rate strengthened, economic growth slowed down and demand forcrude oil struggled to meet expectations. Global inflation is currently soaring, with the US posting an 8.5% year on year increase in March CPI data, the highest since 1981. In order to curb inflation, the Fed's high inflation expectations will further promote the Fed to accelerate the process of monetary tightening. Fed Chairman Jerome Powell said raising rates by 50 basis points at the Fed's May 3-4 meeting would be "one of the options", with a series of rate hikes expected this year. At the moment, the market is also betting on a stronger dollar, with the dollar index now exceeding the 101 mark and stillshowing an upward trend. Against this backdrop, tightening global credit easing remains a major trend. Looking at the growth of the world's major economic regions, the US manufacturing PMI index fell by 1.5% in March, China by 0.7%and the euro area by 1.7%, while from the perspective of the ZWE macroeconomic index, the United States fell to -24.7%, and the euro area fell to -43%. Against the backdrop of a global economic slowdown and a surge in the US dollar index, demand for crude oil is unlikely to reach the expected level this year.
The disruption to demand from the epidemic continues. For the time being, the impact of the epidemic on the demand side depends largely on the attitude of the government. For western countries that adopt general immunization, the impact of the epidemic on demand is limited, but for China, which focuses on isolation and epidemic prevention, the impactremains unchanged. The outbreak in Shanghai has lasted for more than a month and there has been no obvious improvement so far. In addition, Zhejiang, Anhui,Henan, Jiangsu and Beijing have been severely affected by the outbreak. China's refined oil was down 2% in March from the same period last year, withthroughput down to its lowest level since October, according to data released by the market last week. And Chinese demand for gasoline, diesel and aviation fuel is expected to decline 20% year on year in April.
III. Release ofstrategic inventories has limited impact on oil prices
Currently, crude oil inventories in countries suchas the United States, Japan, and the United Kingdom, France, Germany and Italy are essentially at 5 year lows, while they are still in the destocking cycle, and low inventories will still support oil prices. In an effort to curb therise in oil prices, on April 1, after the US announced that it would release 180 million barrels of SPR in 6 months at a rate of 1 million barrels/day, the IEA then announced that it would jointly release 120 million barrels of SPR among the member states, with the US generally taking half the amount. This isthe third time since 24 November 2021 that strategic inventories have been released to curb oil prices. Currently, U.S. crude oil strategic inventories have fallen to the lowest level since 2002. Following this round of releases,the US strategic reserve will be close to 300 million barrels, close to a 90 day safety line based on net US imports of 3 million barrels/day, and there is limited scope for further release of strategic stocks later. At present, the short-term solution to the release of strategic oil reserves is the problem of tight supply, which will have a certain inhibitory effect on oil prices in theshort term. But the core is that the release of strategic crude oil stocks onlysolves the problem of "blood transfusion", and does not solve the problem of "blood supply". In the current process of global crude oil inventories gradually bottoming out, the impact of the release of crude oilstrategic inventories is limited.
Taken together, crude oil price will remainvolatile in the short term, with Brent crude generally fluctuating between US$95-120/barrel. It is recommended to sell high and buy low.
