Oil prices have experienced wild swings over the course of the year. Looking forward, what can we anticipate for the oil market in 2024? To gain insights on the outlook of oil and the implications for investors, we turn to Bruce Liegel, a macro fund manager whose Global Macro Playbook newsletter is aimed at money managers and traders.
Below is a summary analysis by Liegel. The full version of his analysis is set out in his research paper “Oil: What a Fracking World”.
Key Takeaway
Oil’s peak around $125 from 2022 is likely to serve as a ceiling for the market over the next 2-3 years. It appears that the market is in a $70-90 price range until the market moves lower next year, possibly dropping below $60. OPEC has recently implemented another cut, and it seems probable that they will keep cutting production due to weakening demand and resilient non-OPEC supply.
The Bull Case
OPEC's Strategic Supply Restraints
Saudi Arabia, Russia and other OPEC+ countries have repeatedly demonstrated their commitment to maintaining a price floor for oil. In October 2022, OPEC+ implemented a cut in oil production by 2 million barrels per day (mb/d). This reduction represents a 4.5% decrease in the organization's overall supply, with the intention of shoring up oil prices that have been adversely affected by concerns related to a looming recession.
The group has continued to enact a series of additional cuts, with Saudi Arabia and Russia recently confirming their voluntary oil supply cuts throughout 2023. Collectively, these actions have raised concerns about a broader market deficit. The mid-year upswing in prices was seen as a reflection of these concerns.
OPEC+ has reclaimed its clout in the oil market and demonstrated its ability to tighten markets through extended or new production cuts. This will exert upward pressure on oil prices.
Geopolitics
There has been a conflict in the Middle East for some time now. Nobody knows geopolitically what is going to happen, but the crude oil market is highly responsive to geopolitical developments.
After an initial jump in oil prices in the wake of the Hamas attack, oil prices came back down to $75/bbl level. However, the broader instability in the Middle East remains a significant risk. We might see more geopolitical risk being priced into the oil market going forward.
Push factor from SPR
The crude oil stocks held by U.S. Strategic Petroleum Reserve (SPR) have plummeted to a 40-year low due to a series of emergency drawdowns initiated in 2020. The SPR had over 650 million barrels in 2020, but it only has 350 million barrels in storage now, with a majority of the release took place between April 2022 and August 2023. The Biden administration was trying to subdue higher inflation by driving down oil prices, the release of the SPR was their attempt to cap oil prices.
While the release put the bull market on hold, liquidating half the storage — intended for emergency use — has now put the US at risk if there is indeed a price spike due to a bigger geopolitical or exogenous event. Any effort to restore these diminished reserves will now act as a price pushing factor.
Fracking
In the US, fracking is receiving a bad reputation. The investment into drilling and production has dropped off over the last three to five years, and it is not coming back any time soon. Part of the problem for oil is that it is now considered a dirty resource and is not attracting the interest it did 10 years ago. A lot of the traditional energy investment funds are now flowing into green projects like EV, solar and battery storage.
In addition, the profitability of many of the E&P companies was suspect during the initial surge in drilling 10 years ago, hurting many investors, giving them little incentive to invest again.
As a result, the number of oil wells being drilled has decreased, and the count of drilled but uncompleted wells (DUCs), particularly in the Permian region, has sharply declined.
Just a few years ago, the Permian had over 3,500 such wells; today, that number is below a thousand. This shift signifies a change in drilling practices, where the surplus of DUCs that previously acted as a market cushion has disappeared.
All these set up a supply-demand imbalance in the US, exacerbated by a reduction in drilling activities.
The Bear Case
Waning demand and increasing non-OPEC supply
Oil Demand appears to be slowing, which is one of the drivers in oil working lower over the past couple months.
It is always challenging to get an accurate estimate on global oil demand, but by all measures it appears China demand is also falling. Crude oil spreads are the easiest way to see how oil demand is being impacted. Chart 1 shows January 2024 NYMEX crude oil versus June 2024. The spread has dropped dramatically since October, falling almost $7 a barrel. This shift in the curve is impacted by not enough demand for crude – hence global stocks are building. Chart 2 shows the correlation between the price of crude (January NYMEX in Orange) versus the Jan-June spread.
Some of this is weather related, some of it can be a slowing economy, but some can also be attributed to growing global supplies, with Iran production and exports increasing.
There is also increasing supply in the US and other areas, and warming relations with US and Venezuela
OPEC continues to reduce overall production, but these factors are overwhelming the cuts so far — driving prices lower.
The other big factor driving prices lower today is that high prices drive production. Just a year ago prices for WTI were $110-125. This level of high price incentivizes investment and increases production, and can take 2-3 years to work through the system. That is the big factor that the market is adjusting to now.
Chart 1: January 2024 crude oil versus June 2024 crude oil
Chart 2: January 2024 crude oil (LHS in Orange) versus the January/June spread
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
