“That would be the road to hell for America,” JP Morgan’s CEO Jamie Dimon said last week, referring to a suggestion that all big banks divest from the oil and gas industry. In the same week, Aramco’s chief executive warned that years of underinvestment in new oil production are beginning to bear fruit, which is an undersupplied market.
Despite these statements that suggested oil prices should move higher, oil fell for much of the week. Yet it wasn’t dragged down by fundamentals. Oil prices are down because many traders and investors are bracing for a recession.
The bad news is that even in a recession, oil prices can go higher, and this is exactly what some of those banks that kept JP Morgan company at last week’s Congress hearing expected.
Actually, JP Morgan was one of the bullish forecasters. Last week, the banking major’s analysts wrote in a note that they expected Brent crude to rebound to $101 in the fourth quarter. The analysts cited tighter supply as the reason for their forecast.
Goldman Sachs is even more bullish. Three weeks ago, the bank’s analysts said Brent could hit $125 next year despite the oil price cap touted by the G7 as a tool both for keeping the market supplied with Russian oil and for lowering prices. They remain bullish to date.
Morgan Stanley is a little more modest in its price expectations, seeking Brent crude at $95 per barrel in the last quarter of the year. It’s worth noting that this is a downward revision of the bank’s price outlook for the fourth quarter, which happened two weeks ago, prompted by growing recession fears.
UBS also revised down its price expectations earlier this month, again citing recession concerns as well as the continued flow of Russian oil to Asian importers. That downward revision, however, brought Brent to $110, with analysts noting it could rise to $125 by the end of the third quarter of 2023.
The reasons that the Swiss bank gave for the expected rebound are as interesting as they are worrying. According to UBS, oil prices wouldn’t rebound because of a recovering global economy. They would rebound because of the greater demand for oil products for electricity generation and because of tighter overall markets as the U.S. ends its SPR oil sale program.
During the current quarter, oil prices have slumped by 20 percent, Bloomberg noted in a report on bank forecasts about its price. The reason, once again, had nothing to do with supply and demand dynamics. It had a lot to do with central bank policies and specifically the Fed’s aggressive move to rein in inflation by a quick succession of rate hikes that have pushed the dollar a lot higher, making commodities priced in the currency more expensive.
On the fundamental front, the G7 is pushing ahead with the oil price cap, even though Russia said that it would simply not sell oil to a country enforcing a price cap. The EU, for its part, is currently discussing yet another package of sanctions against Moscow following the news that four eastern Ukrainian regions would be holding referendums to join the Russian Federation.
Meanwhile, OPEC+ keeps falling well short of its production targets, and this will likely continue. In addition, some analysts expect the cartel to implement more production cuts, further squeezing global supply.
In the U.S., inventories in the strategic petroleum reserve are at the lowest in decades, and this has worried some. Others, like Robert Rapier, have pointed out that the SPR is not as vital for the country’s supply as it used to be decades ago when the U.S. was heavily dependent on oil imports.
What the above suggests is what Aramco’s Nasser warned about last week. The oil market is not in balance, and supply is getting tighter because there is little in the way of new supply to make up for natural depletion, which has been accompanied by other factors such as political instability and U.S. sanctions on large producers.
At the same time, with the EU tightening the sanction screws on Russia, chances are that gas prices will remain elevated, which will result in what UBS noted as one factor for higher oil prices: greater demand for fuels to use in the generation of electricity instead of even costlier natural gas.
“The consequence of global inventory drawdowns is that once demand picks up, the upshot in prices will happen all over again,” Morgan Stanley global oil strategist Martijn Rats told Bloomberg. “For now, demand has taken a step back, but the supply picture hasn’t changed that much; the supply ceiling is not that far away at all. As soon as demand picks up, we will have the same price pressures in the market again.”
In a nutshell, this is the ultimate reason why oil prices will likely soon be on their way back up. Supply growth is stalling while demand is about to pick up. And depending on how strongly it picks up, we could see a lot higher oil prices next year.