Oil market could remain tight without investments

Macroeconomic and geopolitical factors have caused severe volatility in oil prices this year, and a CIBC analyst says the market is likely to remain tight if producers don’t invest in new capacity.

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“A number of supply and demand factors are exerting forces on the market that are pushing and pulling the price day to day and week to week,” said Daniel Greenspan, senior analyst and resource team director with CIBC Asset Management, in a late-June interview.

Oil has moved from a low of US$76 per barrel in January to a peak of US$124 in early March, before falling below US$100 per barrel this month.

On the supply side, Greenspan said near- to medium-term factors include the war in Ukraine, sanctions on Russia and the supply responses from OPEC+ and North American producers.

On the demand side, rising interest rates around the world and lockdowns in China caused by Covid-19 could impact growth and demand.

Some economists are also warning that a recession could affect oil prices. A recent TD report said a mild recession in advanced economies could bring WTI prices to US$70 “or even lower.” A BMO report forecast WTI to average US$95 per barrel next year, but said the price could fall to US$75 in a recession.

Russia accounts for approximately 10% of global oil supply and, according to Greenspan, even if there is a near-term resolution to the Ukraine conflict, sanctions are likely to remain in place for the medium term. In the short term, most Russian barrels will likely find a home in the global market, albeit at a large discount, Greenspan said. 

Ultimately, he said ongoing sanctions will reduce supply from the country over the medium term.

Regarding OPEC+, in recent years Greenspan said there’s been limited investment and very few members have spare capacity they can bring to market.

“Once OPEC is back to full production levels over the next couple months, there’s little more production it can bring without making material investments in growth,” he said. 

Closer to home, there is also a limited appetite for North American suppliers to add volume.

“The theme of capital returns to shareholders rather than investing for growth remains firmly in place,” he said.

Key risks in the near term include more supply than expected coming from North America or OPEC, higher prices causing demand destruction, demand pulling back due to Covid lockdowns in China, or easing Russian sanctions, although Greenspan said the latter is unlikely. 

As for the medium to longer term, Greenspan said without a shift to a growth mindset from producers and an investment in new capacity, the oil market will remain tight.

“We’ve seen very limited investment in growth over the past number of years, and that narrative is not yet shifting,” he said. 

However, he noted that producers are in a tricky spot. Access to capital isn’t as readily available as it has been in previous cycles, so producers will have to fund growth from cash flows and operations. Further, with travel restrictions easing around the world, demand should remain reasonable, which could keep the oil market tight. 

Lastly, looking at the longer term, Greenspan said the transition to a lower-carbon economy is inevitable and will ultimately become a headwind to oil. However, he said the timing of this transition is still unknown and will depend on several factors. 

“Our general view is that the transition to green energy will be challenging and somewhat longer dated than current government-set targets would suggest,” Greenspan said. 

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