The most obvious characteristics of the crude oil market at this stage are: the macro situation deviates from the fundamentals of supply and demand to a certain extent, market sentiment frequently switches, and the expected difference is constantly revised. Unlike general commodities, the supply and demand sides of crude oil are both very rigid. However, whether the supply shortage is alleviated or the demand is a negative feedback mechanism, the overheated market will eventually return to a balance between supply and demand. Overall, we can be cautiously optimistic about the crude oil market in 2023. The crude oil market will gradually return to rationality, and the oil price center will oscillate in a range that is higher than the average value in the past five years, with extreme values unlikely to occur.
Poor energy consumption and relatively reasonable pricing
In the past three years, the crude oil market has experienced dramatic trends, and the short term is often dominated by consistent expectations. In 2022, the conflict between Russia and Ukraine will push geopolitical risks to the extreme, and the Federal Reserve’s interest rate hike will give early feedback on expectations of economic recession in Europe and the United States. But in the final analysis, it is changes in fundamentals that affect market equilibrium.
The current crude oil bull market cycle that started in the second quarter of 2020 is mainly dominated by the supply side. OPEC regained its crude oil pricing power by resolutely implementing its production reduction policy and became the biggest winner. It has become a long-term fact that Russian crude oil exports are subject to European and American sanctions. U.S. shale oil is subject to environmental protection policies and capital expenditure restrictions, and its price elasticity is low. It is expected that the structural tension on the crude oil supply side will be difficult to resolve for a long time to come.
Against the background of the rise of new energy, the lack of new growth points, and the expected economic recession in Europe and the United States, it is expected that the growth rate of crude oil demand will slow down significantly, which will exert a long-term suppression on oil prices. Due to poor energy consumption due to declining global economic growth and slow demand recovery, the three major international energy agencies EIA, IEA and OPEC have all revised downward their estimates of global crude oil demand.
The characteristics of the international crude oil market at this stage are: contradictions between macroeconomics and supply and demand fundamentals, and deviations between reality and expectations. Despite this, the current crude oil pricing is still relatively reasonable, various influencing factors have received relatively sufficient feedback, and the market performance is more rational than in the past three years.
Switching between increasing and reducing production, OPEC has flexible tactics
From the perspective of global crude oil supply, OPEC represented by Saudi Arabia and non-OPEC oil-producing countries represented by Russia have joined forces. The United States is not strictly an energy exporter, so OPEC+ monopolizes most of the market share. As we all know, crude oil is a seller’s market, and exporting countries have absolute say. Therefore, OPEC+ production policy occupies an important position in the international crude oil pricing mechanism. In 2022, OPEC+ has adopted three production policies: increasing production, reducing production, and waiting and seeing.
The picture shows the proven oil reserves of various countries (unit: 1 billion barrels),
The picture shows OPEC crude oil production (unit: thousand barrels/day)
In the early stages of the Russia-Ukraine conflict, market concerns about crude oil supply interruptions intensified, and international oil prices soared and remained around US$100 per barrel for a long time. Under the temptation of high oil price dividends and strong appeals from Western countries, OPEC countries, led by Saudi Arabia, have steadily increased production with a plan to increase production by 400,000 barrels per day month by month. However, the plan soon faced difficulties. Most member countries were restricted by factors such as insufficient investment, unrest, and international sanctions, and it was difficult to maintain the ability to increase production. After the second quarter of 2022, OPEC+’s actual crude oil production has not reached the standard.
As the impact of the Russia-Ukraine conflict and subsequent sanctions on the supply side was less than expected, international oil prices peaked and fell. In order to defend the dividends of high oil prices, OPEC+ launched a new round of 2 million barrels/day production reduction agreement. Regardless of the impact of sanctions on Russia on supply, OPEC+ is expected to actually reduce production by less than 1 million barrels/day.
At present, given that the outlook for the crude oil market is still unclear, OPEC+ announced that it will temporarily maintain the existing production reduction agreement to wait for changes. OPEC+ reiterated that it will adhere to a proactive and pre-emptive strategy and can convene an extraordinary meeting if necessary to take additional measures in a timely manner to respond to changes in oil prices. Next, OPEC+ will evaluate the impact of sanctions on Russian crude oil exports and the global market, and observe the demand prospects of major consumer countries as a basis for future decisions.
OPEC+ members hope that the focus of oil prices will remain at the Brent benchmark of US$80-90 per barrel. If the price of Brent crude oil remains below US$80 per barrel for a long time, it may trigger OPEC+ to initiate further production reduction mechanisms.
The Russia-Ukraine conflict is at a stalemate, and Western sanctions are implemented
In 2022, the major event in the crude oil market will be the conflict between Russia and Ukraine, and the two sides are still in a stalemate.
Russia is the world’s second-largest crude oil exporter, and Europe relies on Russia for about 40% of its natural gas imports. More importantly, Russia’s main pipeline to Europe passes through Ukraine. The Russia-Ukraine conflict is a typical black swan event, triggering extreme market concerns about the European energy crisis and crude oil supply disruptions. International oil prices once reached US$140/barrel and have remained above US$100/barrel for a long time.
At present, the EU’s embargo and price limit sanctions on Russian crude oil exports have taken effect, and the export price of seaborne crude oil is capped at US$60/barrel. Russia has stated that it will not accept this and will only sell its products to buyers willing to cooperate under market conditions.� is one of the barometers for measuring the strength of the spot market. At the beginning of the OPEC+ production reduction in 2017, the return of OECD crude oil inventories to the five-year moving average was the goal of the successful production reduction plan. The U.S. crude oil and oil product inventories released weekly by EIA are the most important inventory indicators in the industry.
The picture shows that the OECD crude oil supply and demand gap still exists
Changes in U.S. commercial crude oil inventories can reflect the supply and demand relationship in the crude oil market over a period of time. With crude oil supply and demand maintaining a tight balance, U.S. commercial crude oil inventories will remain low in 2022. Excluding seasonal factors, the inventory accumulation performance will not exceed expectations. However, judging from recent EIA inventory data, although crude oil inventories remain depleted, refined oil inventories have increased significantly, and full-caliber inventories have actually rebounded. According to previous experience, crude oil demand is relatively weak from the end of each year to the first quarter of the next year, and crude oil markets in the United States and other northern hemispheres will usher in a phase of inventory accumulation, so it is difficult for crude oil inventory data to have bright spots in the future.
In addition to the commercial crude oil inventory system, there is also the Strategic Petroleum Reserve (SPR). In March 2022, the Biden administration launched an unprecedented 180 million barrels of oil storage plan to ease the tight supply situation. Judging from the information disclosed by the IEA, there is no new strategic oil release plan after this round of stockpiling, and the total SPR inventory is getting smaller and smaller. Failure to cover under the current international situation will undoubtedly affect energy security. It is reported that the U.S. Department of Energy plans to replenish strategic reserves when international oil prices fall to as low as 67-72 US dollars per barrel.
The pace of interest rate hikes slows down and hawkish stance softens
Oil prices are closely related to macroeconomic operations. As we all know, the petrodollar cycle is the backbone of the U.S. financial system. Mainstream transactions in the international crude oil market are priced and settled in U.S. dollars, and the Federal Reserve’s monetary policy will also affect oil price trends.
In recent years, the Federal Reserve’s monetary policy has been based on economic data such as U.S. CPI and non-farm payrolls. The U.S. CPI increased by 7.1% year-on-year in November 2022, recording the smallest increase in several months. U.S. inflation is lower than expected, triggering market speculation about the Federal Reserve changing its hawkish stance in the future. The market generally expects the Federal Reserve to slow down the pace of interest rate hikes and even complete this cycle of interest rate hikes ahead of schedule.
The picture shows the strengthening of the U.S. dollar index restraining the rise of oil prices
After raising interest rates by 75 basis points in November 2022, the Federal Reserve raised interest rates by 50 basis points as scheduled in December. As the damage to the economy from violent interest rate hikes deepens, some officials from the Federal Reserve have hinted that it is time to start discussing slowing down the pace of interest rate increases, and even consider stopping raising interest rates in early 2023 to avoid causing the economy to fall into an “unsustainable state” due to an excessively aggressive pace of interest rate increases. “forced recession” crisis. Previously, the international crude oil market has fully reflected the expectations of the Federal Reserve to raise interest rates. If the pace of interest rate hikes slows down and brings about a difference in expectations, it will cause safe-haven funds to flow out of the U.S. dollar, which will support the rebound of international commodity prices, including crude oil.
However, Powell said that the Fed must maintain effective restrictive interest rate levels for a period of time and will not cut interest rates until inflation returns to its target level. There is still a long way to go to restore price stability. These remarks cooled down overly optimistic market sentiment. Judging from the published economic data, the conditions for ending the interest rate hike cycle are not yet met.
Expectations have been revised repeatedly, and long and short views are viewed dialectically
The most obvious feature of the crude oil market at this stage is that the macroeconomic situation deviates from the fundamentals of supply and demand to a certain extent, market sentiment frequently switches, and the expected difference is constantly revised. As mentioned before, there is a certain gap between expectations on both sides of crude oil supply and demand. The supply tightness and demand recovery are not as good as expected. The resonance between strong supply and demand is weak, and oil prices have fallen by more than 40% from their high levels.
Unlike general commodities, the rigidity of both the supply side and the demand side of crude oil is very strong. Judging from the current global crude oil supply, a decline in total production in the future is almost inevitable. The market is worried that the economic recession and radical interest rate hikes in Europe and the United States will suppress global energy demand. Therefore, whether the crude oil supply side shrinks actively or passively, the crude oil supply will return to a balance position that matches demand.
In addition, any expected or realistic factors should be viewed in a reflexive manner. Whether it is the alleviation of supply shortages or the negative feedback mechanism of price transmission, overheated oil prices will eventually cool down until they return to a balance between supply and demand. As the international security situation worsens and the risk of economic recession in Europe and the United States intensifies, commodities including crude oil and even most risky assets will be affected.
The picture shows the crude oil market returning to a balance between supply and demand
Overall, the crude oil market is cautiously optimistic in 2023. Take the Brent benchmark price as an example: the low point of oil prices is determined by the supply side and geopolitical risks. If the center of gravity falls below US$80/barrel, it is likely to trigger the OPEC+ defensive production reduction mechanism. The high point of oil prices is determined by the demand side and macro expectations. If it reaches US$100/barrel or higher, the negative feedback effect of demand on high oil prices will be amplified. In the future, the crude oil market will gradually return to rationality, and the oil price center will oscillate in a range that is higher than the average value in the past five years.
Rationally, the oil price center will oscillate in a range that is higher than the average in the past five years.
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