Eric Nuttall: The bullish supply-demand case for oil — looming recession aside (Part 2)5 Oct 2022 09:39
Furthermore, with European natural gas prices trading at a material premium to oil equivalence, as much as 700,000 barrels per day of fuel switching potentially exists, especially with the now zero chance of Europe importing further natural gas via the Nord Stream pipelines due to recent sabotage.
Combining the already undersupplied state of the oil market with these supply factors could alone offset any recessionary induced demand weakness, yet there are also bullish supply factors that are being overlooked.
First, OPEC is meeting this week to consider whether to cut production, which would act as a circuit breaker against further price weakness. A cut of one million barrels per day or more is quite possible, and would help narrow the vast difference between the physical demand for oil, expressed in falling inventories, and the collapse in the financial demand for oil, expressed in the 33 per cent drop in oil prices from earlier this year.
Second, U.S. shale companies, coinciding with the historic volatility in oil prices and the growing uncertainty on 2023 oil demand, are now beginning to set their drilling budgets for next year. With production growth disappointing expectations so far this year, amounting to only 182,000 barrels per day from December 2021 to July 2022, the likelihood of continued production shortfalls owing to low-to-no growth budgets in 2023, especially with inflation of 20 per cent or more in service costs eroding spending power, has materially increased.
The best setup for investors is when the oil price discounts the likely worst-case scenario, so they get free optionality on the current reality as well as the upside associated with better days ahead. That, in my opinion, is what energy investors get today.
Last week, Goldman Sachs Group Inc. in a report said that after the most recent price plunge, oil now discounts zero growth in global gross domestic product in 2023, something that has only been seen in the post-war era during the great financial crisis and the COVID-19 pandemic.
With the end to the largest SPR release in history next month, likely ongoing tepid U.S. shale growth, fuel switching, normalizing Chinese demand and the potential for a production cut that sends a signal OPEC will not stand idly by and watch the price of oil fall further, the case for a strong ending to the year and another great year for energy investors in 2023 is strong.
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