It was a choppy third quarter for crude oil prices which averaged at around the $85-$90/b range, down about 30% from peaks reached in early March, with the “black gold” torn between expectations of a global economic slowdown, the hawkish reactions by central banks to fight record high inflation, the zero-Covid policy in China, and the stronger U.S dollar, despite the soaring geopolitical risks over Russia-Ukraine military conflict, and the lower-than-expected supplies from OPEC+ and non-OPEC producers due to the chronic underinvestment conditions into the global oil industry in recent years.
Neutral Outlook for Q4, 2022:
Base scenario: We expect the Brent and WTI crude oil prices to be averaging at $95/b and $90/b respectively throughout Q4, and trading into a range between $85/b-$100/b.
Bullish scenario: Brent crude oil price could revisit July 2022 highs of $110/b range on China reopening, a weaker dollar, the tight supplies, the Russian oil embargo, and G7 price caps, up approx. 20% from the current levels of $90/b (Oct. 01).
Bearish scenario: Brent crude oil price could break below the $85/b key support level (2022 low) in case recession fears outweigh tight supply worries, a stronger dollar and yields, and stricter Covid-led lockdowns in China.
In our view, the bullish OPEC+ production cut, the geopolitical instability, the supply disruptions coming from the military conflicts in Ukraine, Libya, Iraq, Yemen, Nigeria, and others, and the EU sanctions on Russian crude starting from December 05 should stabilise the Brent oil prices between $85-$95 per barrel in the Q4, despite the growing concerns for lower petroleum demand following the deteriorating economic conditions around the world.
On top of that, a combination of short-term bearish market dynamics should constrain oil prices from rising much beyond $110/b territory before the year’s end, including the stronger U.S. dollar and the higher U.S Treasury yields after hawkish Federal Reserve, the 40-year record-high inflation, the ongoing Covid-led controls on business activity in China, and the growing concerns for a deeper recession in Europe.
Bullish price catalysts that should support oil prices in Q4:
OPEC+ 2 million bpd production cut:
The oil prices will remain supported in the Q4 after the Organization of the Petroleum Exporting Countries and its allies including Russia, together known as the OPEC+ alliance, decided in early October to cut its collective crude oil production by a gigantic 2 million barrels per day until December 2023.
Yet, the real impact of the move would be only around 1,1 million bpd, as several OPEC+ countries are already pumping well below their existing quotas due to civil wars, and chronic underinvestment. In August, OPEC+ missed its production target by 3.58 million bpd, exacerbating the tight supply conditions in the global market.
OPEC’s biggest production cut since the Covid-led 9.7 million bpd decrease in May 2020, was the response by the organization to falling oil prices, the SPR releases from the Biden administration, and to address weakness in recession-led global demand.
Beyond that, the slashing output signals OPEC+ efforts to stabilize or add an “unofficial” price floor on Brent crude prices around the $90/b key level, despite the criticism from the western countries, while it also indicates an even tighter global physical oil market ahead, supporting oil prices higher.
Strong crude oil demand:
We expect the global oil demand to remain solid in the final months of the year supported by strong diesel and jet fuel demand, despite the growing fears of a global recession, the new COVID lockdown measures in China’s industrial hubs, and the weaker manufacturing activity in Europe due to the energy crisis.
The long-term outlook remains bullish for the oil demand as the Organization of Petroleum Exporting Countries (OPEC) said in its 2022 World Oil Outlook that fuel demand will be higher than initially expected in the medium to long term and will likely plateau by only 2045.
Hence, with natural gas prices and energy costs skyrocketing since the start of the Russian-Ukraine war on February 24, industries and households across Europe and Asia have been looking for crude oil to be used in short-term to replace the expensive natural gas for energy generation and heating.
Diesel shortage will cause higher oil prices:
We believe that the real energy crisis is not crude oil or natural gas, but diesel, the workhorse of the global economy, deteriorating the inflationary pressure for consumers, governments, and policymakers.
The demand for diesel coming mainly from farming, heating, and trucking surged to its highest seasonal level since 2007 heading into the winter, at a time supplies hit yearly lows due to restrictive regulations that have led to a historic shortage of refining capacity.
The diesel shortages drama across the US and Europe due to years of underinvestment in refining capacity, refinery closures during the pandemic, hurricane-led operation disruptions, and the expected sanctions on Russian refining oil starting from February 05, 2023, should cause higher fuel and crude oil prices in the final months of the year.
The scarcity of refining oil is higher in the United States than in the rest of the world, with the country having only 25 days of diesel supply in reserve as the diesel inventories have been on a stable decline for months, reaching the lowest level since 2008 as of October.
Energy traders will start diverting cargoes with refined products such as diesel, gasoline, and jet fuels that were originally bound for Europe and Asia toward the U.S, triggering fresh distillate shortages and higher oil prices on the pump across the world.
There will be a real meaningful impact on demand growth outlook in the energy market if China reopens, offsetting the weaker fuel demand growth in Europe and other parts of the world.
The spectre of China to ease Covid-led restrictions to boost its beaten-down economy, will increase hopes of a pick-up in demand for crude oil and distillates, including diesel and gasoline, in the second largest oil importer in the world.
European Union sanctions and G7 price caps on Russian oil:
Crude oil prices should find support on expectations of tighter petroleum supplies globally ahead of the already-announced European Union sanctions and G7 price caps on Russian oil exports, which are intended to reduce Moscow's oil revenues in response to the country’s invasion of Ukraine.
Disruptions to global oil supplies are expected when the EU’s ban on Russian seaborne crude oil imports takes effect on December 05, 2022, while the group also plans to block imports of Russian refined oil products such as gasoline, diesel, distillates, mazut, petrochemicals, kerosene, and others on February 05, 2023.
Hence, the G7 group of major industrialised nations is also looking at the mechanics of placing a price cap (the most likely range would be between $63-$64 per barrel—the historical average price for crude) on Russian energy exports, which will have a material impact on Russia's supply and by extension global supply.
The G7 does not want to stop all oil exports from Russia but rather only to limit how much revenue it can make from each barrel, with Russia earning nearly $18-$20 billion per month after the Ukraine invasion.
Yet, this event should be bullish for oil prices, as Russian President Vladimir Putin has said that Russia would respond to a price cap by suspending deliveries to countries where it is implemented, which could drive global oil prices higher.
Hence, we are doubtful over the effectiveness of the EU sanctions and G7 price caps, given that major Russian importers China, Turkey, and India have given little indication they will comply, while it will only affect fuel exports to the Western allies.
Lack of spare capacity:
Another bullish signal in the energy market is the lack of global spare oil production capacity, with only few producers such as Saudi Arabia, UAE, and Kuwait having together of around 1,5 million bpd spare capacity.
The lack of spare capacity rises the uncertainty among energy traders as the thin buffer capacity would not be enough in case of any geopolitical-led supply disruption or China winds down its zero-COVID policy and aviation demand fully recovers to pre-pandemic levels (the jet fuel demand remains some 1.7 million bpd below pre-pandemic levels).
Geopolitical instability supports oil prices:
The global energy markets should also remain on edge following the recent escalation in Ukraine, driven by the sabotage of Russia’s state Gazprom-owned Nord Stream 1 & 2 gas pipelines, and the explosion on the Kerch strait bridge, a road-and-rail bridge linking Russia and the Crimean Peninsula.
The U.S. government is trying to bring down gasoline prices ahead of the November midterm elections, while European Commission wants lower oil prices to minimize the economic damage of the energy crisis in the Eurozone ahead of the coming winter period.
As a result, we expect the additional geopolitical risk to give an extra premium in oil prices ahead, as the western countries may want to cut or freeze diplomatic cooperation with Saudi Arabia, the de facto leader of OPEC over the output cut decision, given that higher oil and gas prices benefit Russia-the other leader of the OPEC+ alliance- to fund its illegal invasion of Ukraine.
A weaker dollar on hopes for a slowdown in Fed tightening campaign:
A possible U.S. dollar weakness on a less hawkish Federal Reserve should also add support to the crude oil prices, as the recent greenback’s strength to multi-decade highs against major peers, has been a notable factor preventing energy market gains.
Since the Federal Reserve’s aggressive tightening cycle is already causing a slowdown in the U.S. economy (according to the latest data), sentiment is building among economists and policymakers to possibly scale back the pace or size of future interest rate hikes to temper recession risks, starting from December.
The Federal Reserve has consistently been increasing interest rates to push back against persistent inflation, which climbed to more than 8% during summer.
The view that the Fed could begin to pivot in December is a bullish catalyst for the crude oil prices, as it could also put a full stop on the turbo-charged rally on U.S. dollar and bond yields, making the dollar-denominated crude oil and other commodities more affordable or less expensive to holders of other currencies.
On top of that, other major central banks are expected to announce smaller-than-anticipated interest rate hikes or even get closer to the end of their historic tightening campaign in the following months, which could also boost the economic environment and improve the crude oil demand growth outlook.
SPR crude oil releases and a price floor around $70/b
We believe that the sale of a record 180 billion barrels of oil from the U.S. Strategic Petroleum Reserves (SPR) that began in May to drive down crude oil and gasoline prices before the November 08 midterm elections, is only a short-term solution with long-term consequences for crude oil prices.
U.S. President Joe Biden has announced recently that his administration would aim to be to refilling the reserve when U.S.-based WTI crude is around $70 a barrel, adding a price floor and a strong support level for the crude oil prices.
Overall, the U.S. needs to buy back nearly 200 million barrels to refill SPR reserves, with $72 per barrel of oil being the upper limit the Biden Administration has set for stating repurchases of crude, adding to global demand when prices are around that level.
Bearish price dynamics that may cap oil prices from rising beyond $100/b level
The bullish oil supply fundamentals and soaring geopolitical risk will collide in the following months with the short-term economic fears of a global recession, constraining oil prices from rising much beyond $100/b territory before the year’s end.
The ongoing efforts of some major central banks such as the U.S. Federal Reserve, the Bank of England, and the European Central Bank to curb the 40-year record high inflation by tightening their monetary policies and lifting the interest rates might slow down the trade and manufacturing activity.
The growing pessimism over global economic growth has been a bearish catalyst for oil prices over the last months, with Brent and WTI crude prices retreating from 2022’s highs of $140/b touched after Russia invaded of Ukraine in early March to the lows of $80-$90/b at end-September due to recession-led demand concerns.
A stronger U.S. dollar hits fuel demand growth:
The surging U.S. dollar is a bearish catalyst for oil prices since it reduces demand for petroleum products by making them more expensive for buyers using other currencies.
The strong dollar and the higher crude oil prices are causing troubles for some of the world’s biggest oil importers, India, China, and the European Union, ballooning national bills for their oil imports and trade deficits.
This would, in turn, increase the challenge for their economies during the recession, causing problems with the balance of payments as various parts of the business activity would slow down due to higher oil prices, leaving downside risk for global oil demand.
Bearish “zero-Covid” policy in China:
Crude oil prices might remain under pressure in Q4 from concerns over further Covid-led weakness in fuel demand from China, the world's second-largest oil consumer after the USA.
The sustained “zero-Covid” policy in China is another negative catalyst of crude oil demand and prices, as in response to any fresh Covid outbreak in the country, Chinese authorities usually close some public spaces where the virus could spread, and extend quarantine times, leading to a severe drop in fuel consumption and demand in that area.
However, the bearish sentiment could be reversed in the following weeks as there is a speculation that China was planning to scale back its strict zero-COVID policy to support the local economy.
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