We remain bullish on the crude oil prices for the second quarter of the year based on the mismatch of the demand-supply oil dynamics given the reopening of China which will boost demand, and the surprising decision from the OPEC+ alliance to further slash output until the end of the year in a bid to avert a further slide in oil prices.
We also remain cautious about the major central banks of the Federal Reserve, ECB, and the BoE potentially raising interest rates to curb persistent inflation, which could slow economic growth and reduce petroleum demand.
Despite the macro factors affecting the price trajectory of the two benchmark oil grades, we believe that the leading price catalyst in the second quarter and as well as in the rest of the year would be the supply cuts by the Organization of the Petroleum Exporting Countries (OPEC) and its allies, led by Russia, known as OPEC+. The alliance includes 13 OPEC members and 11 non-OPEC members mainly from the ex-Soviet Eurasia region.
In early April, OPEC surprised the market by announcing voluntary output cuts of 1.16 million barrels per day (bpd) from May till the end of 2023, saying that it was a “precautionary” move to support the stability of the oil market after the steep losses in March due to the banking crisis.
Let’s remind that last October, OPEC announced its decision to cut output by two million barrels per day from the August 2022 required production levels, starting November 2022 until 31 March 2023, to trim some surpluses that started to accumulate since mid-2022 due to lower Covid-led global fuel demand.
Adding on the OPEC cuts, Russia also announced on the same day an extension of its 500k bpd production cut until the end of 2023, with the supply cuts totalling around 1.650 million bpd, helping both Brent and WTI crude oil prices to bounce off sharply from yearly lows of $70/b and $64/b respectively, hit after the collapse of the two regional U.S. banks and the recession fears.
Finally, the unexpected decision by the OPEC+ alliance brings the total volume of cuts to 3.66 million bpd including a 2 million bpd reduction in October 2022, representing roughly 3.7% of global demand.
Bullish Q2, 2023 Outlook:
Base scenario: Brent crude to trade on an average of $85/b in Q2, 2023
We remain bullish on the crude oil sector as we expect the price of Brent (the benchmark for two-thirds of the world’s oil) to trade at an average of $85 a barrel in the second quarter of the year on the back of the imbalance between demand-supply dynamics.
We expect the global oil market balance to turn into a deficit after May when the supply cuts from OPEC and allies will be fully implemented at a time when demand growth for gasoline and jet fuels will start accelerating amid the beginning of the driving season and summer holiday period in U.S., Europe, and Asia (Northern Hemisphere).
Adding to the above, China, the world’s largest crude oil importer and the second-largest consumer just after the USA, is recovering from its strict 3-year-long Covid-led restrictions. The resumption of business, industrial, and tourism activity and the pending-up demand for traveling, could also boost fuel demand.
Another bullish factor for oil prices is the fact that U.S. SPR inventories are at their lowest levels in forty years, with rumours mounting about the need to refill them soon.
Dollar-denominated crude oil prices could also see further support from a weaker dollar and falling bond yields. A weaker dollar could also boost global demand for oil by making it cheaper for holders of foreign currencies in other countries.
March’s banking crisis and the softening U.S. economic data could force Federal Reserve to slow down its aggressive monetary tightening to save the local economy from a recession, which in turn, will pressure the greenback lower in favour of crude oil prices.
Bullish scenario: Brent crude to climb up to or surpass the $100/b key psychological level
Our bullish case scenario assumes Brent oil prices to reach or even break above the $100/b key psychological level during the second quarter on some unexpected supply disruptions events, geopolitical risks, and a better-than-expected demand from China.
A $100/b projection includes a scenario that a hurricane could impact the oil-rich U.S. Gulf Coast ahead of the start of the U.S. hurricane season, which starts in June and until October.
There has been always a risk that a hurricane could halt the operations of the U.S. Gulf Coast refineries as well as cease the drilling on the offshore oil and gas platforms, which produce up to 15% of total U.S. crude output.
Hence, the surprising supply cut from OPEC+ and the ongoing Ukraine war is expected to intensify geopolitical risks by adding a risk premium on oil prices.
U.S. administration has criticized OPEC+ action given market uncertainty, adding further strain between Western allies-Eurasia ties, which is a bullish event on oil prices given the higher risk for supply disruptions.
Hence, the higher-than-expected recovery growth scenario in China amid successful stimulus measures, and the return to normal mobility without any further Covid outbreaks, could be the leading factors for a surge in China’s oil demand and the push of the price of Brent above the $100/b key level.
Bearish scenario: Brent crude to retest $70/b on a weaker fuel demand:
Our bearish scenario assumes Brent oil prices to fall back to Q1’s low of $70/b in case the ongoing aggressive monetary tightening by the central banks to curb inflation, the stronger U.S. dollar and bond yields, the recession fears, or any new collapse in the global banking sector could negatively impact the fuel demand growth despite tight supplies.
The surprising oil output cut from OPEC+ will threaten to strengthen inflation at a time when it was starting to reverse lower after the record-high readings in the preview months, forcing central banks to continue maintaining higher rates for longer.
Based on the above inflation-led assumption, our bearish projection is based on the scenario that higher-for-longer interest rates and negative consumer sentiment from the looming economic and banking crisis could deteriorate the global economic and industrial growth that would, in turn, cut demand for crude oil and petroleum products.
A similar case was seen back in 2008 when the financial crisis and the lower demand crashed the oil prices from record-high levels of $140/b to the lows of $30/b in just a few months in that year.
Finally, higher oil prices will bring fresh barrels into global markets, especially from U.S. Shale producers and from offshore Brazil which could inject over 500k bpd by the end of 2023, pushing lower the oil prices.
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