Some very prominent banks (Silicon Valley Bank, Credit Suisse, Signature Bank) are shaking the very foundation of the financial system, which is spilling over and causing some significant downward pressure within the oil markets. No doubt this all appears frightening, but let’s step back and take a look at what it really means for the long-term outlook of oil pricing.
Why oil is experiencing some serious downs
The current credit financial crisis is causing significant contagion and uncertainty in the commodity markets, notably, in the oil markets. What happened? Silicon Valley Bank (SVB) announced it would sell $2.25 billion in common equity and preferred convertible stock to make up for losses from investments in long-term government bonds. In the 72 hours following, the collapse of SVB created credit instability fears causing Brent to drop nearly $10 in mid-March, approximately 13%, to its lowest settlement since Dec. 3, 2021.
Is your heart racing yet?
To help calm squeamish investors, the U.S. Federal Reserve and other central banks announced a joint liquidity operation to increase the frequency of their U.S dollar swap line arrangements. In good ol’ U.S. bank bailout fashion, the government is completely backing depositors’ money to stabilize the ailing markets. But the damage has already been done. There is a significant slowdown in M&A deals as the bid-ask spread of oil is a problem for deals during periods of increased price volatility since sellers may be reluctant to let go of assets at current strip without significant financial pressure.
With all this turmoil, the Federal Reserve needs to tread lightly as it balances taming aggressive inflation without putting the economy into a nosedive. However, if the Fed decides to slow down its interest rate increases or even decrease, then this may be a boon for mergers and acquisitions.
That story is yet to be told, and Enverus Intelligence® | Research (EIR) will surely provide their take as it unfolds. But what you should focus on right now is that this credit crisis is temporary.
No financial crisis should be taken lightly; there are many far-reaching implications that occur and not all are predictable. However, the quick response to bail out and restructure ailing banks is all an effort to stop depositors from moving their hard-earned funds out of the bank at the same time, triggering what’s known as a bank run.
As the markets calm, you should concentrate on the more entrenched issues driving the oil markets. Focus on what EIR thinks are longer term forces that will significantly drive up the price of oil in the second half of this year.
The oil rebound: What goes down must go up?
In early 2023, the EIR group predicted that Brent oil prices would rise to $100/bbl in the second half of the year. Despite the uncertainty caused by the recent dip in oil prices, they remain optimistic about the long-term outlook of the oil industry and anticipate a significant rebound in the second half of this year due to a lack of supply growth and moderate projected demand.
Here are the key factors driving up the price of Brent WTI oil:
1. China continuing to relax COVID-19 restrictions and reopening their economy to the world
EIR predicts a ramp-up in production as China, the world’s biggest crude importer, continues to open up to the world. Positive economic data shows an uptick in manufacturing and services activity in the country. They expect production to increase to 0.73 MMbbl/d this year due to rising U.S. orders for capital goods. While China currently has access to cheap Russian supply, it is unlikely that Moscow can redirect all formerly European-bound oil to China.
2. The end of the shale revolution: North American production to peak by 2030
The EIR team observes that the shale industry’s more than 15-year revolution is winding down as low-cost inventory becomes scarce, leading to a projected peak in North American production by the end of the decade. In the short term, operators are focusing on optimizing their remaining inventory to avoid child wells’ degradation. In the longer term, consolidation is likely to lead to fewer companies developing the remaining inventory or exploring new basins outside of North America. Additionally, potential tailwinds for price restoration include the U.S.’s need to refill the Strategic Petroleum Reserve. The Permian Basin is expected to drive the most global oil supply growth, but it may struggle to offset Russian losses.
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3. OPEC+ maintains current oil production targets amid uncertainty around Chinese demand and EU sanctions
At a virtual meeting of its market monitoring committee Feb. 1, OPEC+ decided to maintain its current oil production targets. Delegates cited uncertainty around the rebound of Chinese oil demand as the country eases COVID-19 restrictions, and a lack of clarity on the impact of EU sanctions on Russian crude oil exports imposed in early December. Although the organization reduced output in November and intends to maintain these targets through the end of 2023, it has also warned that it will not hesitate to make further cuts if oil demand weakens due to recession risks. While there is early evidence to suggest that Russian oil exports have remained strong in January, EIR suggests that the EU’s ban on Russian oil product imports, which went into effect Feb. 5, is expected to keep European diesel balances tight.
4. Russia/Ukraine War: Russian supply falls to 9.6 MMbbl/d by the end of 2023
According to Refinitiv shipping data, Russian crude oil loading programs have significantly dropped in February. As of Feb. 9, loading departures amounting to 2.3 MMbbl/d were programmed, compared to 4.8 MMbbl/d in January, which was slightly higher than the pre-sanctions level from November 2022. By the end of the first quarter, Enverus anticipates Russian crude exports to decrease by 1-1.5 MMbbl/d from pre-sanctions levels, which would reduce production to 9 MMbbl/d as sanctions take effect.
Despite this, The EIR team does not anticipate Moscow being able to divert all formerly European-bound oil to other markets, particularly China and India. The EU not only sanctioned Russian crude but also imposed restrictions on insurance and other maritime services for ships carrying Russian oil. Nonetheless, Russia has built up a shadow-fleet of more than 100 vessels that could potentially operate outside of the sanctions and is selling its oil at a $35-$40 discount to Brent while paying higher freight rates.
In December, India prioritized imports of Russian oil, taking 1.25 MMbbl/d of Russian crude, which was equivalent to 25% of total oil imports, compared to only 1% in 2021. In early March, Russian pipeline company Transneft ceased crude deliveries to Poland via the Druzhba pipeline after Poland delivered its first Leopard 2 tanks to Ukraine.
5. ConocoPhilips receives approval for Willow project in Alaska
The March 13 record of decision by the U.S. Department of the Interior has granted ConocoPhilips permission to proceed with the Willow project in the NRA-Alaska, utilizing three pads instead of the originally proposed five. The project has undergone five years of regulatory and environmental review and now received approval. Conoco intends to begin constructing gravel roads immediately and will proceed with internal approval processes towards an FID. The Willow project is seen as timely amidst the banking crisis, although the media’s reports on its size and impact are being exaggerated. This is widely believed to be a shift in policy for the Biden administration, who seems to be placing a larger emphasis on energy security and therefore will not pressure the oil and gas industry as heavily moving forward.
The following graph generated by EIR certainly speaks for itself as total demand is predicted to well outpace supply, with Brent oil prices rising to $100/bbl in the second half of 2023 and remaining there for the next five years due to a lack of supply growth and moderate projected demand.
Key factors contributing to this prediction include:
- China’s reopening.
- Modest U.S. supply growth.
- OPEC+ maintaining targets and a decrease in Russian crude exports due to sanctions.
- The approval of ConocoPhilips’ Willow project in Alaska is seen as timely given the current banking crisis, although its impact is being exaggerated in the media.
Despite recent uncertainty, the long-term outlook of the oil industry remains optimistic. To stay informed on industry developments, you can review our past Analyst Takes here, or subscribe to our LinkedIn page.
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About Enverus Intelligence®| Research
Enverus Intelligence Research, Inc. is a subsidiary of Enverus and publishes energy-sector research that focuses on the oil and natural gas industries and broader energy topics including publicly traded and privately held oil, gas, midstream and other energy industry companies, basin studies (including characteristics, activity, infrastructure, etc.), commodity pricing forecasts, global macroeconomics and geopolitical matters. Enverus Intelligence Research, Inc. is registered with the U.S. Securities and Exchange Commission as a foreign investment adviser. Click here to learn more.