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Oil prices have been experiencing increased volatility recently. Greg Bonnell speaks with Daniel Ghali, Senior Commodity Strategist at TD Securities, about the challenges facing the sector, and how supply uncertainty is likely to influence pricing in 2023.
Transcript
Greg Bonnell: We are continuing to see volatile trading in the price of crude oil. Investors are weighing, of course, supply with demand concerns. But our featured guest today says any downward pressure on oil might just be the markets pricing in a Goldilocks scenario that may not play out. Joining us now for more, Daniel Ghali, senior commodity strategist at TD Securities. Daniel, welcome back to the program.
Daniel Ghali: Thank you, Greg. Thanks for having me.
Greg Bonnell: Okay, so let’s dig into this because this has been quite– I mean, quite a couple of weeks, quite a year, but even just quite a couple days between oil erasing its gains for the year, and then suddenly back above $80 a barrel. What’s going on over there?
Daniel Ghali: Yeah, no, you’re absolutely right, Greg. And, you know, there’s a sense out there that commodity markets participants and the markets in general are celebrating kind of the end of the energy crisis. There’s good reason for that because crude oil prices are now back, you know, nearly where they started the year off. You have demand concerns emanating from the fact that we’re barreling towards a recession, and the reality is that the supply side of the equation more recently has actually caught up despite previous underperformance.
And so all of these things together have created a context in which oil prices have come off substantially and in which people are starting to look at the future and thinking that well, perhaps the worst is behind us when it comes to the energy crisis.
Greg Bonnell: What should they be thinking, though? If that’s what they’re thinking, are their heads in the right space?
Daniel Ghali: Well, exactly. I think there’s a little bit of complacency out there in markets. When you think about the demand side of the equation, certainly, demand is going to slow. But the critical caveat here is that the oil demand across the world is still going to grow nonetheless, perhaps at a slower rate, but it’s still going to grow. And the main question that that brings up is where is the marginal barrel going to come from. And if you follow me down kind of that rabbit hole, you quickly start to see holes in the narrative.
Let’s talk about where those barrels might come from. First, the US, one of the world’s largest producers of oil – there has been – and I fear repeating myself. We’ve certainly discussed this several times over. But there’s been a historical disconnect here between the price of crude oil and the production that we’re seeing out of the US and out of other parts of the world.
Part of that is driven by the ESG concerns that are prohibiting capital expenditures in that sector. But the other part of it is that the behavior of these participants has changed. People or stakeholders want these companies to return capital to them as opposed to reinvest into their operations.
Outside of the US, most of the growth out there that the market is expecting for next year is coming from a few producers, and none of that growth actually has to do with the high price environment that we’re in. It’s a result of legacy projects that just happen to be coming to completion over the next year. So that leaves us with all the other producers, namely within OPEC+. And that’s where most of the risk lies when it comes to production next year.
All right, let’s talk about Russia as one of the most evident pieces of supply risks out there. So far, Russian exports have actually been doing quite well. Part of that story is the world is stockpiling because they fear the sanctions that are coming are going to disrupt their output, and so the world has stockpiled in anticipation of that. And another part of the story is that, really, nobody knows what the sanctions are going to look like, particularly with respect to the G7, and how that’s going to impact oil markets come that day.
Another part of the story is within the broader OPEC group. Libya is one nation where we’ve seen a tremendous amount of geopolitical risk, and the country is still facing a political crisis that has been ongoing since 2014. And you still have an election season that is coming up that could, once again, bring forward some production risks from this nation. Don’t forget that earlier this year, we lost about a million barrels a day from Libya. If we lose that again into next year, who’s going to make up for that lost supply?
Greg Bonnell: With all this uncertainty and all these variables and moving pieces, it seems to me that we’re not going to get past this volatility anytime soon. Right now, I’m looking at West Texas Intermediate, the American benchmark, up almost 3%. The other day, I was looking at it down almost 3% in one session. It’s kind of whipsaw action. I guess we’re not going to get much relief from it if that’s the backdrop.
Daniel Ghali: No, absolutely. I think volatility is here to stay. Part of that story is liquidity has been significantly hampered. That’s true across all global markets, but I think particularly so in crude oil, where you’ve had an exodus from the money manager space, mostly because money managers were positioned for a disruption from the G7 sanctions. And thus far, the reports that we’ve had are that the sanctions are going to be watered down or that there’s a lack of consensus among the G7 participants on how strict to be on Russian oil sanctions.
Greg Bonnell: It seems every time we get past an OPEC meeting where some kind of decision has been made, then we’re saying, oh, in that upcoming meeting. There’s always this cycle of OPEC meetings and what they may or may not do. Does OPEC want to see a certain level of crude prices?
Daniel Ghali: Well, I think, certainly, we’re at levels that would be consistent with what you’d call the OPEC put or the strike on the OPEC put. What that means is that OPEC would probably be comfortable with higher prices than where we are today. And the reason we say that is because prices are really close to where they ended their historic agreement last meeting and where they had their first production cut since the pandemic.
If you think about it, spare capacity globally is really concentrated among a few nations who are at the helm of OPEC. They are essentially, today, the swing producers in oil markets, and they have a grasp on this market because of all the issues that we previously discussed, with the US and other producers out there. So it is in their interest and in their power to keep oil prices more elevated.
Greg Bonnell: Now, earlier this year, only a couple months ago, there was some tension between what OPEC was up to and what Washington wanted to see in terms of crude oil prices. And, of course, you had the Biden administration tapping the strategic petroleum reserve. How does that story wind up? I mean, at some point, you can only tap it so much.
Daniel Ghali: Yeah, I mean, that’s absolutely right. There’s a lot of moving pieces in there. You mentioned the discontent between Saudi Arabia and the US when it came to both the SPR and OPEC’s decision to cut. When you think about the big picture geopolitical risk in the Middle East, you have one nation – Iran, namely – that is facing already significant sanctions, that is making progress on their nuclear ambitions, and that is really destabilizing the balance of power in the Middle East.
So that is an incentive for Saudi Arabia to keep their strategic relationship with the US. But at the same time, when you’re looking forward 10 years down the line, and oil demand is expected to decline, you might want to monetize that as much as possible for the time that you can.
Greg Bonnell: So with this much uncertainty, this much volatility, this many moving pieces, can we even attempt to put a price around what we think we might see a barrel of oil go for, on average, heading into next year?
Daniel Ghali: Yeah, absolutely. And, you know, I think most of sell side banks expect higher oil prices. The reasons are typically because supply is constrained, and we also agree with that view. And, you know, we’re looking at oil prices to rally north of $100 a barrel, so we’re still – there’s still a significant amount of upside here.
The key idea, I think, is that the right tail in oil markets is really fat. So while we think oil price is going to go to $100 a barrel, it won’t take a huge disruption to see prices go to $120 a barrel either.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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