We have seen strong moves higher in the key crude oil benchmarks-WTI, and Brent, in the last several months. This was initiated by the advent of positive news on the Covid front that the vaccines in development were extremely efficacious, promising an endpoint to the spread of the virus. This upward trend in crude was boosted by the gradual decline in U.S. shale production and inventories over the same period.
Finally, the move in early January, by OPEC+ to restrain output into mid-2021, and an extra “gift” from Saudi Arabia to remove another 1 million BOPD from the market, provided the impetus for WTI to rise firmly into the $50s. In this article, we will discuss key reasons that we think the upward trend for crude will continue this year. Why?
Demand will return:
Despite the current lockdowns which inhibit demand, the trend is higher. As implementation of the vaccines increases the pool of the virus-immune population, business activity will resume creating demand for refined petroleum products. The graph below shows the EIA’s, Energy Information Agency, forecast of the trend for refined products over the next couple of years. For gasoline, the primary motor fuel used in the U.S. moves gradually higher in the second half of 2021, and then moderates in 2022, just below the levels of 2019. The EIA makes some assumptions about work from home and reduced commuting in this forecast. The forecast is not so robust for jet fuels, showing slight growth in 2021, but a return to near 2019 levels in 2022. Total demand increases to and slightly exceeds 2019 levels by 2022.
The political and macro environment will push supplies lower:
Elections have consequences. The concentration of power over the next couple of years, with Democrats controlling all three branches of government, will make increases in U.S. production very unlikely. From recent 2020 highs where the U.S. produced over 13 mm BOPD, production in response to low prices has fallen to 11.0 mm BOPD. We will see an enhanced and stricter regulatory environment in the coming years. The U.S. will be put firmly on a path where renewable fuels are increased at the expense of petroleum-based fuels. The anticipated re-entry of the U.S. into the Paris climate accords will only exacerbate this trend. Fossil fuels will become scarcer, and that is bullish for prices.
OPEC+ has surprised the world with its resolve to finally push prices higher. Using its might like one of the world’s top three crude oil producers, and its unchallenged position as the world’s lowest-cost producer, Saudi Arabia unilaterally chose to withdraw another 1-million BOPD from global markets beyond its OPEC+ commitments. It was this action that moved the oil markets above $50 for the first time since early March 2020. What this suggests strongly is that the cartel is resuming its traditional role of setting crude prices for the world.
The decline of U.S. supplies will return pricing power firmly to OPEC+. The recently obtained $50 handle is likely to be a floor price going forward. The glut we’ve had to deal with over the last few years will continue to dissipate as capital restraint by U.S. shale producers keeps the overall trend down. OPEC+ really has only one mission-providing the maximum return for its members by balancing supply and demand. The western economies’ current infatuation with climate change, is less of a motivator for the key countries that make up OPEC+. Their economies are driven primarily by the export of crude oil, and they all want higher prices.
OPEC+ resuming the swing producer role is bullish for oil prices.
Commodity prices will boom:
No commodity is more fundamental to the world economy than crude oil. Among the things that drive crude oil other than scarcity is the fact it’s priced in dollars, which makes it very susceptible to inflationary pressures.
The dollar index has declined over the last year but has recently seen support with a weeklong trend higher. A stronger dollar is bullish for oil prices because you get less oil for the dollar which means you need to spend more of them to get the same amount. This is inflationary and as noted above crude is very susceptible to this pressure.
WTI Long (Buy)
ENTER AT: 54.43