OPEC, geopolitics and macro headwinds counterbalance to keep oil prices in a narrow range
A little over a decade ago, oil prices were on the cusp of touching all-time highs as a wave of popular uprising against the authorities swept through the Arab world. Starting in Tunisia, the movement popularly known as the ‘Arab Spring’ – for its promise of ushering in a new era of governance and change, and also its timing – had spread rapidly. And the reaction in the oil market was understandable. Public anger and protests had already overturned the government in OPEC member and key North African producer Libya. Yemen was sucked in. With unrests reaching the streets of Bahrain, the fear of a spread to top producer and neighbor Saudi Arabia was palpable, which would have jolt oil markets with shocks the likes of which hadn’t been since the 1970s. Another once-in-history crisis engulfed the region last month, following an unprecedented and deadly attack on Israel by Hamas. Israel retaliated with force and a subsequent ground invasion that has flattened entire neighborhoods in the Gaza Strip. While a fragile truce has been reached, the escalation still runs a real risk of spilling over to regional heavyweights, particularly Iran – an ardent supporter of the Palestinian cause. This again raises the specter of disrupting oil supplies through one of the busiest trade routes.
And yet, the oil price reaction has largely remained muted after a brief spike soon after the 7 October attack on Israel. The limited reaction, and an overall bearish outlook, stands out even more given that another unprecedented geopolitical event – Russia’s invasion of Ukraine, which upended global markets and trade flows last year – continues to grind on. Both these risks can easily take a turn for the worse rapidly and, taken together, pose a clear and present danger to oil supply and trade. Still, the ‘risk premium’ on prices, a term that journalists, analysts and think tanks alike would use often during the peak of the Arab Spring, is non-existent today.
Part of the answer to the puzzle could be an uncertain macroeconomic outlook. The US has successively raised its benchmark interest rate in an attempt to curb the runaway expansion in inflation that was partly on account of supply chains struggling to cope with the post-pandemic demand surge. The increase, aimed at tightening money supply has, however, led to a sharp surge in the cost of capital for households and businesses who had become accustomed to near-zero rates. That rapid expansion in lending rates had prompted concerns of the US sliding into recession. Over in Asia, powerhouse China’s growth story, following the lifting of Covid-19 restrictions, has faltered. Together, an uncertain growth in the top two economies can understandably dampen the demand growth outlook for oil, even vastly overshadowing the steady growth in India – a nation that is rapidly climbing the scales but is still a much smaller consumer compared to the other two.
While the reasoning seems sound from a high-level perspective, a closer look at the data tells a different story. The US economy is far from entering a recession – gross domestic product (GDP) expanded at 4.9% in the third quarter. While job growth slowed down to 150,000 in October, the lowest in 2023, it remains robust and far from the deceleration a recession would suggest. The inflation outlook is improving. The so-called ‘momentary goldilocks’ the US finds itself in is giving the Federal Reserve room to pause its phase of tightening and to allow for economic activity to recalibrate. Financial market trends, including US equities, are reflecting the sound footing of the economy. At the same time, China, while still dealing with a real estate bust, has managed to grow at above 5% on average so far this year, countering a growing narrative about a significant slowdown in the country. India, the other emerging giant, has been doing even better, with latest reported second-quarter growth coming in at 7.8% and real-time traffic data showing continuous strength through October. The only major region that looks increasingly weak is the European Union, with close to zero growth in third quarter. But even that needs to be put in perspective, as it comes off a very strong growth base of 2022. While still high, inflation has been easing in the Eurozone, too, which bodes well in terms of its monetary policy going forward.
So, why is the prevalent sentiment bearish when it comes to expectations for 2024? Our macro analysis signals show that the bearishness is on account of the hard-to-sustain government budgets and deficits. The US has been running a deficit of more than 5.7% of its GDP so far this year, India is at 5.9%, China at 3.9% and even the frugal Eurozone is at 3.4%. Government largesse of this magnitude is significantly higher than the historical norm – outside of major recessions – and masks underlying economic weakness. With interest rates high, and unlikely to be lowered anytime soon, it will cause interest payment on government debt to swell, reducing governments’ ability to finance expenditure. If lowering expenditure is politically not an option, it will force governments to borrow even more, spinning a cycle of more loans feeding an ever-expanding debt. The practice is not sustainable in a high interest rate environment. Hence, the day of reckoning – when fiscal support is trimmed – may soon be approaching for Europe and perhaps even China, while it will likely not occur in the US before the November presidential election.
The slightly bearish 2024 sentiment is partly justified by the unsustainable government deficits that have so far buttressed the economic recovery. As these deficits are likely to be reduced next year – with the notable exception of the US due to presidential elections – global growth would stand to suffer.
Despite market sentiment indicating demand growth concerns in 2023, the strength in oil consumption has puzzled most market watchers. The perception was that China’s economic recovery would start to weaken in the second quarter and never fully recovered and – as a result – demand had to weaken. Yet, reality has been different. Rystad’s Real-Time Data has shown global road transport has held up well despite a slight weakening in China’s road transport, right as China’s petrochemical sector grows rapidly. To provide some perspectives, in July we had forecast 2023 world’s demand growth at 2.1 million barrels per day (bpd), but we had increased it to 2.5 million bpd by October. This is one of the strongest growth rates ever recorded and there are no signs of weakening in the fourth quarter. Crucially, we believe that an oil price of $90 per barrel, our Base Case for the next few quarters, is unlikely to put any downward pressure on economic activity.
OPEC made three successive cuts this year, decreasing production by almost 2.5 million bpd. Saudi Arabia announced additional voluntary cuts in the summer, bringing its crude output down to just below 9 million bpd from 10.5 million bpd in December 2022. This market share “sacrifice” generated a boost in prices, with Brent climbing from average $78 per barrel in the second quarter to average $86 per barrel in the third. On November 30, OPEC+ agreed an additional cut of approximately 0.7 million bpd, on top of Saudi Arabia’s extension of its voluntary cuts of 1 million bpd through the end of the first quarter in 2024. Russia joined with 0.3 million bpd in crude export cuts and 0.2 million bpd in product export cuts. Important to remind that all these cuts are voluntary and supposed to expire at the end of the first quarter 2024. It is clear that without the OPEC and Saudi cuts, Brent would not have been in such a steep backwardation, and prices would have likely languished at around $70-$75 per barrel. The key question is: for how long can the OPEC price floor strategy be sustained?
Despite a weaker macro market sentiment and oil demand returning to mean growth, there is no signal of the market shifting away from backwardation – as long as OPEC+ and Saudi Arabia are willing to support it. Oil prices are expected to hold around the high $80s. We believe that a tight market, together with a geopolitical risk premium due to the Israeli-Hamas conflict, should provide support to oil prices in the coming months.
What are the signposts to watch that could shock the oil markets in 2024?
Some of the carryover signposts from 2023 to 2024 include a sudden reversal in OPEC policies, major political shake-ups in the US, Russia and India and deepening of the recession in the EU. The Israel-Hamas conflict becoming a full-blown crisis in the Middle East and military action by China on Taiwan are some of the other key headlines to watch. The growing divergence in views on long-term oil demand will continue to add to the disruptive volatility in the short term, as reduced financing for oil and gas assets erodes the buffer capacity to react.
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Senior Vice President, Oil Markets, Head of Americas Research
Vice President, Analytics
(The data and forecasts contained in this column are Rystad Energy’s and the opinions are of the authors.)