Brent crude oil has rallied sharply since early December and touched a post-2014 high of nearly USD90/bbl.
Oil prices have surged as demand concerns fuelled by the lightning spread of the Omicron variant eased. The more contagious but milder Omicron wave seems to have solidified expectations that the Covid pandemic will evolve into a more manageable endemic phase of the virus and thus lowering the risk of stop-start global growth.
Supply pressures in the context of low level of oil inventories have also driven up oil prices. First, OPEC+ consistently missed its production quotas even as OPEC+ has continued to power ahead with 400 kb/d monthly increments to the aggregate output target. Libya’s production outages added to this underperformance.
Oil prices higher, driven by concerns over supply disruption along with resilient demand
Source: Bank of Singapore, Bloomberg.
Second, oil prices rebounded to nearly USD90/bbl despite an increase in US oil inventories in recent weeks. This suggests that geopolitics, rather than fundamentals, are currently dominating price movements, which we believe will remain volatile. Geopolitical tensions in the Ukraine pose the risk of sanctions on Russia, heightening worries of disruptions to oil flows from Russia, which have driven up crude oil prices. Being one of the world’s largest oil producers, with a 12% market share, Russia is of significant importance to the oil market. Russia is also the second-largest natural gas producer. About 45% of EU natural gas imports are from Russia.
An adverse supply-driven increase in oil prices is historically more problematic for the global economy compared with demand-driven rise in oil prices. The stagflation challenge from supply shocks, by boosting inflation while weighing on economic growth, could cause further headaches for policymakers.
Given the near-term oil market tightness, we increase our 3-month Brent oil forecast to USD95/bbl (old: USD80/bbl). We cannot rule out further near-term price overshoot above USD100/bbl if geopolitical tensions worsen. We also revise our 12-month Brent forecast up a tad to USD78/bbl (old: USD75/bbl).
Medium-term price risks remain to the downside as the oil market is set to become better supplied by 2H22. OPEC+ is set to continue unwinding its cuts at a monthly rate of 400kb/d, as it has done since last July. The OPEC+ supply increases are set to bring relief to the tight oil market by mid-2022. Meanwhile, the strength of oil prices is spurring a return of growth in US shale supply. Sustained high prices have left US shale producers flush with cash. Privately held companies that are not subject to investor pressure will have especially strong incentives to increase output.
US shale supply is back in growth mode
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