December will be a pivotal month for the energy markets: The 20th National Congress of the Chinese Communist Party in October may give way to an easing of restrictions and an increase in demand. The Strategic Petroleum Reserve (SPR) releases from Western powers and any residual effects will have fully concluded, removing some artificial supply from the system. The US mid-terms in November may shift market expectations in a more hawkish, but energy friendly direction.
Energy rationing in Europe should be underway, and public sentiment poor. COP 27 in Egypt will have just concluded, with energy security and investment in the developing world as key points of debate. Budget announcements from the major energy firms will also begin to appear in the news. The next meeting of OPEC+ on December 4 will be closely watched after the events of the October meeting. Russian oil will be subject to an embargo/price-cap on December 5, and lastly, major events in Ukraine often line up with symbolic dates, and December is filled with them.
All this near-term uncertainty makes it incredibly difficult to think further out because of the wildly diverging paths ahead, leading to ‘analysis paralysis’ or a ‘wait and see’ attitude. For forecasters with a publication schedule to keep, this is not a luxury afforded to us. As such, we must rely on probabilities, scenarios, and assumptions to generate a base case that has the least likelihood of being proved wrong before public release. With all this in mind, the outcome that makes the most sense for now is one of pragmatism, or as we call it the ‘Cool Heads’ scenario where all actors are– mostly– rational.
First, OPEC+’s cut is not as surprising as the media would indicate. Prior forecasts by the King Abdullah Petroleum Studies and Research Center before the Ukrainian crisis repeatedly highlighted the need for a temporary cut as the market rebounded from the pandemic. The lack of downside impacts on Russian exports – some were expecting 4 MMb/d or more, but it was closer to 1 MMb/d – and the offsetting impact of the SPR releases means that our pre-crisis outlook was not too far off in aggregate. The recent actions of OPEC+ were in preparation for an uncertain winter, and building some spare capacity is a safety measure against a sharp drop in supply. Slightly tightening things now may be appreciated later.
The shale industry, while historically a fast follower of price, is muted, citing investor and ESG demands for holding back development. While not drilling at the same pace as before, there is still growth pushing total production beyond the highs of 2019. The need for stable revenues and returns has matured the industry, making them more predictable and a lot less ‘unconventional’. Whether the balance swings one way or the other, shale will likely follow a growth path of about 800Kb/d in 2023 and 2024, with any real changes occurring in 2025 in response to policy levers from the administration at that time.
Oil demand and concerns over demand destruction, may be a little misplaced. The pandemic was a perfect natural experiment to determine how low consumption could go to maintain minimum economic activity, and the surprising result was not that low.
After a temporary drop averaging 13 MMb/d in Q2 2020, the average deficit for 2020-21 was 5 MMb/d, or 5% below ‘normal’. However, recent scenario analysis indicates that despite slowing economic growth and a risk of recession/stagflation, demand will continue to grow independent of GDP forecasts due to the ongoing rebound from COVID-19.
So, assuming OPEC+ attempts to balance the market, shale is relatively steady, and demand is not too responsive without severe price hikes, this brings us to the core question: Russia. Unless Russia decides to intentionally cut their exports (unlikely for financial reasons), or the Western alliance can effectively enforce the embargo/price cap (which is also unlikely), we will probably see a market in 2023 that looks much like the market of late 2022. This would entail relatively stable supply, demand, pricing that may be elevated but not record-breaking, and enough spare capacity to address downside shocks.
After all the events listed at the top of this article, the result here may be disappointing to some, but it is a plausible outcome that the market could find an equilibrium. Disruption is not desirable for anyone, and a return to the mean has a high probability despite the headline.