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As China’s economy reopens, there is speculation the country’s demand for oil could help offset concerns about the impact of a global economic slowdown on prices. Kim Parlee speaks with Hussein Allidina, Head of Commodities at TD Asset Management, about the outlook for the commodity.
Transcript
Kim Parlee: Crude oil prices have been all over the map in the last 12 months. It was over $120 a barrel last summer when we lost Russia as a core supplier but has since dropped back to around $80. Will the volatility continue? And will demand come back since China has reopened? Joining us in studio, Hussein Allidina He’s head of commodities at TD Asset Management. Always great to have you here.
Hussein Allidina: Thanks for having me.
Kim Parlee: Let’s start– like I said, the range has been big for crude oil prices. You’ve got things that will move oil prices higher and things that move them lower. So let’s just go through the list to see where you think things are going. China– the reopening of China. What do you see the impact on that?
Hussein Allidina: Yeah, so China is obviously a very material consumer of all commodities, crude included. Last year, 2022, when China was shut demand, decreased in China by about 500,000 barrels a day. On average, pre-COVID, if you look at Chinese demand growth, it’s averaged around 600,000 to 700,000 barrels a day. That’s like the five-year average before COVID.
Kim Parlee: Yeah.
Hussein Allidina: So if you go from being down 500,000 barrels a day, now the economy is opening, reopening. The IEA has pegged Chinese demand growth at 800,000 barrels a day next year. That still doesn’t get you back to kind of trend levels of demand growth. But definitely on a year-on-year basis, a big, big swing as it relates to the demand balance.
Kim Parlee: There’s a look at the chart right now in terms of just, as you mentioned, what you could actually see coming from them. Is there anything that’s going to change, I guess? The IEA is saying what they expect their estimate to be. Have behaviors changed? Has travel changed? I don’t know. Are there things that you’re looking at?
Hussein Allidina: So I think if you look at China, China has had a proper lockdown, right? We had our lockdown here in Canada. China has had a proper lockdown. And I think that there’s–
Kim Parlee: I don’t think they would call it proper. But I know what you mean– a full lockdown.
Hussein Allidina: So I think that there’s probably quite a bit of pent-up demand, notwithstanding the fact that you have a very elevated level of COVID in the country right now. People are still traveling. Movie theaters are packed. And with the Chinese New Year this weekend, you’re going to see quite a bit of travel. I think there is a desire to get out and do things.
And so I think that while you may not see demand revert back to the trend levels of demand growth that we saw through the last supercycle, because China is becoming less of a sort of industrial economy and more of a service-driven economy, and because China has more EV vehicles as a percentage of their total, I do think that you still see positive demand growth– maybe not the 2-3 million barrels a day you need to get back to kind of pre-COVID trend levels. But 800,000 barrel-per-day forecast, I think is pretty reasonable from the IEA.
Kim Parlee: Now, when you take a look– so that’s a positive. That’s going to help push prices higher. The negative that you and I were chatting about is weather. Not speaking to China, just in the world, especially Europe, we’re seeing a much warmer winter. How does that net out?
Hussein Allidina: Yeah. So I think in anticipation of the winter, there was quite a bit of stockpiling at the tertiary level and at the reported level. And then the winter didn’t show up. Estimates range that we’ve lost somewhere between 1 and 1.5 million barrels a day of demand owing to weather. That’s only for the sort of late in the fourth quarter into the first quarter. But I think that is what has contributed to the bearishness that you’ve seen in the market, the weakening of the backwardation. It’s actually in the very first few months of the curve, you’ve moved into contango.
Weather does return to normal at some point. That stimulates demand. But that loss has been– that loss in demand has– is exhibited, is illustrated by the build in inventories that you’ve seen over the course of the last several weeks and months.
Kim Parlee: So let’s talk about, then, a supply side. You mentioned build of inventories, which obviously helps us. But what else are you seeing from a supply side in terms of just oil coming out of the ground?
Hussein Allidina: So inventories throughout most of last year drew very meaningfully because of the supply-demand imbalance. You mentioned in the intro that we lost Russian production. We were concerned that we were going to lose Russian production. And that’s what sent prices materially higher in the early part of last year. But we actually haven’t lost any Russian production.
The inventory picture has gotten slightly better because we’ve lost that sort of incremental demand from weather. But again, if I look at the full year, notwithstanding the builds that we’re seeing right now, most forecasts are pointing to pretty stark draws by the second half of the year, again because the supply demand is not balanced.
Kim Parlee: Yeah. When you say we haven’t lost a lot of Russian production, do you anticipate there will be some more to come? Or I mean, that’s hard to say.
Hussein Allidina: It’s hard– I think most folks have been surprised at how resilient Russian production has been. The exports are not going to Europe, but they’re going to China. They’re going to India. They’re going to other countries. Ultimately, I’m worried about Russian production through the medium term. You’re not seeing investment in the country. The expertise that’s required to grow production, to sustain production is not there. You don’t have the Schlumbergers, the Halliburtons, the guys who do the oilfield services that’s required to keep production constant and/or grow. They’re not in the country, right?
Kim Parlee: Yeah. A more technically challenging place to get oil too.
Hussein Allidina: I think you’re going to have a hard time keeping production constant, let alone growing it. I think if we rewind three years, most folks had growth in the Russian balance. And that was how you were going to find equilibrium. I don’t think you’re going to see that.
Kim Parlee: How does this all net out then? Because, I mean, it’s a tricky market, right? You don’t have all forces moving in the right direction. There’s always cross currents. When you also layer into this the US dollar, people are seeing this starting to peak or it’s near its peak right now anyway. When you factor that all in, what do you see for the upcoming year in terms of prices?
Hussein Allidina: Sure. So I try to keep it simple because I get confused, right? I think there’s a bunch of moving parts. The starting point is that inventories are reasonably tight. And spare capacity, the ability of OPEC to respond to any disruption, is also relatively limited. Now when I look forward through 2023, Chinese demand is going to be stronger than it was. So directionally, that’s better. Russian production, at best, is flat or lower. That’s directionally supportive for price.
You mentioned the macro, the US dollar. If the US dollar has peaked and weakens throughout the year, that’s constructive because commodities are priced in dollars. But it’s also fundamentally constructive because the realized price in India is not as bad. The realized price in Brazil is not as bad. So consuming countries, I think we’ll see more demand on a relative basis. Net-net, I’m still quite constructive as I look at the picture through ’23 and into ’24, because we simply are not making the investment that we need to meet that demand.
If you believe, Kim, that the world is going to grow, that growth requires commodities and, in particular, oil. And we’re not investing to bring that supply to fruition. If I look in the US, the US shale producer is what brought supply to the market from 2012 to 2020. They’ve found religion. They’re returning cash to shareholders. They are spending incrementally year on year. But a lot of that CapEx is just being spent to meet the inflation that you’re seeing. There’s been a tremendous amount of cost inflation, labor inflation as activity has picked up. So I think the picture is actually quite constructive, notwithstanding kind of the turbulence we might see from the economic front.
Kim Parlee: I’ve only got 15 seconds. This is unfair to ask. But from a fundamental standpoint, it sounds as though you think, again, volatility but things are trending up. It looks that direction. But from an investor standpoint, in terms of where the leadership is in the markets, are investors becoming more interested in commodities again?
Hussein Allidina: I think the fact that the energy space is becoming a more material part– because of the performance we had last year, energy in the S&P is now 5%, 5.5%. You can’t ignore it. So I think as folks look at it, they realize what we’re talking about is not rocket science. The balance is pointing to tighter forward balances. So I think investor interest will grow as investors are forced to look at the space.
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