Macro Insights Weekly: Oil and 2022 outlook

Commentary: Oil and the 2022 outlook

Strong demand rebound, depleted inventories, relatively soft response from the supply side, and widespread position taking at the option market have kept the upward momentum in the market for crude oil. With Brent crude hovering around USD90, and call option contracts suggesting strong chance of another 10-15% upside, 2022 has begun with bullish sentiments. It is a testament to the market’s resilience given that this has taken place when omicron-led pandemic resurgence has caused travel plans to get cancelled and disrupted a wide range of activities.

Why is oil so buoyant? First, market participants don’t seem to be fearful of the impact on omicron on economic activities, expecting the ongoing disruption to be highly temporary. Second, a big call of last year, that US Shale oil producers will ramp up investment and supply to take advantage of rising prices, has not yet worked out. It appears that many US Shale producers are busy repairing their highly leveraged balance sheets and providing returns to their shareholders than boosting production in the near term.

But supply is not going to be inelastic this year. As per latest report of the International Energy Agency, crude production by Brazil, Canada, and the US would reach record levels this year, lifting overall non-OPEC+ output by 1.8mn barrels/day. The IEA also expects Russia and Saudi Arabia to hit records if remaining OPEC+ cuts are fully unwound. This would imply that global supply would soar by 6.4mn barrels/day this year, comfortably matching or exceeding the increase in projected global demand, even as it returns to pre-pandemic levels. Additionally, global refinery output is expected to jump substantially this year as idle capacity is restored, which reinforces the scenario of well-balanced market fundamentals.

Inventories had fallen sharply in 2021, which fuelled bullish sentiments. But that dynamic is likely to be reversed due to a coordinated response by China, India, South Korea, Japan the UK, and the US to release strategic petroleum reserves to the market. We expect to this play out during the course of the year, which ought to cool market sentiments.

How could this not work out? The ongoing conflict between Russia and the West over Ukraine certainly does not help matters, as it clouds Europe’s energy security. Supply side response could be slower than expected, China’s policy easing could cause a spike in fuel demand from its massive industrial sector, and tension over Iran could spill over on to the spot and future markets. But assuming these risks will be worked out, we think the risk of oil contributing to the bulk of global inflation is unlikely this year.

Taimur Baig

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