The Oil Market Is At The Whim Of Geopolitical Disputes

Oil prices have continued their early-year surge in the new year, thanks in large part to easing worries about omicron as well as tight oil and gas supplies amid growing geopolitical uncertainties.

Front-month Brent reached USD 89.05 per barrel (bbl) in early trading on 19 January, the highest level since 13 October 2014. Brent settled at USD 87.51/bbl, a w/w increase of USD 3.79/bbl. WTI rose USD 4.21/bbl w/w to USD 85.43/bbl, while the value of the OPEC basket of crude oils rose by USD 5.95/bbl to USD 88.08/bbl and by EUR 5.52/bbl to EUR 77.77/bbl.

Along the curve, Brent for delivery five years out settled at USD 66.98/bbl on 18 January, a w/w increase of USD 0.99/bbl and just USD 0.02/bbl shy of a 38-month high. The move higher in prices has been gradual and sustained, resulting in relatively low levels of realized volatility; 30-day annualized Brent volatility stands at 26%, 4.7ppt lower w/w.

According to the latest Standard Chartered commodity report, the most recent push higher in oil prices has been fuelled by two main factors: widespread trader concern about limited spare capacity and demand optimism based on a view that the Omicron wave is waning and is unlikely to hold demand growth back. To wit, South Africa's latest wave of Covid, which began in late November 2021, is now declining as sharply as it once rose and is likely to be declared over, nationwide, in the coming days. Omicron was first reported in South Africa.

Meanwhile, concerns over spare capacity have amplified the effect of geopolitics, making the market highly sensitive to anything that could be perceived as a supply threat. Over the past week, that sensitivity has been shown in response to drone attacks against targets in the UAE and escalating tensions between Russia and Ukraine.

Tight Gas Markets

Three rounds of talks have failed to produce a resolution between Russia, the U.S. and allies to de-escalate the tension on the Russia-Ukraine border, with concerns based on a build-up of Russian forces and associated infrastructure in the area.

The energy market has reacted to the increase in risk and uncertainty with a significant geopolitical premium, particularly in the gas markets, but also permeating into oil. European gas supplies remain particularly tight, despite a moderate winter; gas storage stood at 515.11 Terrawatt hours (TwH) on 17 January, 24.9% lower y/y (2021: 685.6 TwH) and also 24.9% lower than the 2017-21 average (686.23 TwH).

Conflict would likely affect Russian gas transit through Ukraine, particularly if sanctions were enacted. Reuters has reported that the U.S. is investigating contingency plans for natural gas supply to Europe. Maintenance schedules for gas production could also be adjusted. Stanchart analysts have predicted that the situation is likely to lead to significant price spikes, likely to once again impact gas-dependent industries. The U.S. has been a big beneficiary of high gas demand in Europe and Asia, and in December, it overtook Australia and Qatar to become the world's largest LNG exporter.

The latest International Energy Agency (IEA) monthly report puts OPEC+ spare sustainable capacity at 6.47 million barrels per day (mb/d) based on December output, with spare capacity excluding Iran, Venezuela and Libya estimated at 4.98mb/d. Both estimates imply that the market could deal with supply losses of up to 2.5mb/d before OPEC+ spare capacity fell below 5% of total OPEC+ sustainable capacity. However, the consensus among traders is that spare capacity is significantly lower than the IEA estimate.

The latest round of international and national energy agency monthly reports provided no significant reassessment of oil demand prospects. The global oil demand forecast for Q1-2022 was unchanged in the OPEC Secretariat report, revised lower by 50kb/d in the IEA report, and revised higher by 163kb/d in the Energy Information Administration (EIA) report. Demand growth for 2022 is forecast at 3.32mb/d by the IEA (a revision of 20kb/d lower), 4.15mb/d by the OPEC Secretariat (unchanged), and 3.62mb/d by the IEA (a revision of 76kb/d higher).

Views on 2022 oil demand growth in China differ widely. The OPEC Secretariat expects strong y/y growth of 660kb/d, the EIA expects 582kb/d, and the IEA is more downbeat at 470kb/d.

The latest EIA weekly data was highly bullish, according to our U.S. oil data bull-bear index, which rose 87.9 w/w to +52.4. Crude oil inventories fell 4.55mb to a 39-month low of 4.13mb, leaving them 37.32mb below the five-year average and 15.71mb below the 2015-19 average. Crude inventories at the WTI pricing hub in Cushing, Oklahoma, fell for the first time in nine weeks, losing 2.47mb to 34.84mb. The w/w change in the crude oil balance was 829kb/d in the direction of higher inventories; however, this was more than fully offset by a 1.173mb/d w/w swing in the crude oil adjustment term.

The only significantly negative components of the data release were gasoline inventories and demand. Gasoline inventories rose 7.96mb w/w to 240.75mb, a rise of 2.3mb relative to the five-year average, bringing the cumulative increase over the past two weeks to 18.09mb. Implied gasoline demand averaged a 10-month low of 7.906mb/d in the week, in line with the usual early-January seasonal weakness.

After a sharp decline at the height of Covid-related lockdowns, the U.S. and international rig count have been steadily rising over the past few months.

U.S. oil and gas rig count moved above 600 for the first time since April 2020, rising by 13 w/w to 601 according to the latest Baker-Hughes survey. The oil rig count gained 11 w/w to 492, while the gas rig count gained two to a 22-month high of 109.

The w/w increases were led by the Eagle Ford region of south Texas, where the oil rig count rose by four to 45, and the gas rig count rose by a single rig to seven. The Louisiana oil rig count gained four to 21, with the offshore count gaining two to 17 rigs. The Permian oil rig count gained a single rig to 292'; within the Permian, Midland Basin activity added one to 112 rigs while Delaware Basin and other Permian activity were unchanged at 149 rigs and 31 rigs, respectively.

By Alex Kimani for