If last week the broader market was hammered with one big question mark over the viability of the reflation trade, someone forgot to tell oil with Brent today surging just shy of $75/bbl, the highest level since 2018...
... facilitated by the ongoing failure of the Iran nuclear talks to reach a deal (which is widely expected to boost global oil output), although bullish sentiment was also lifted by a series of sellside analyst calls for oil to rise anywhere from $80 to as high as $100 or more.
The first bullish call came from Citigroup, which said that Brent will touch $85/bbl before Q4 2021, with the bank's oil analyst and one-time OPEC advisor, Ed Morse, writing that "we now see Brent oil prices averaging in the high $70s for the rest of the year, with a high probability of touching $85 before subsiding with markets rebalancing." As a result, the bank raised its 2021 Brent price forecast by $4 to $72/bbl and its 2022 estimate by $8 to $67, while the London benchmark is seen averaging $77 in 3Q and $78 in 4Q this year, higher by $4 and $9 versus its previous forecast, respectively.
But a far more notable, and outlier call, came overnight from BofA which in a report titled "Oil's ALl About The Benjamin"..
... analyst Francisco Blanch laid down the strongest call yet among major forecasters for an oil price return to triple digits, writing that oil may surge to $100 a barrel next year as travel demand rebounds, and as global oil consumption continues to outstrip supply in 2022 as the economic recovery from the pandemic boosts fuel consumption, while investment in new production is crimped by environmental concerns, the bank said in a report.
Summarizing this super bullish thesis, Blanch writes that "a combo of factors could push oil to $100/bbl (a “Benjamin”) next year, mostly on three key demand and three key supply factors."
- First, there is plenty of pent up mobility demand after an 18 month lockdown.
- Second, mass transit will lag, boosting private car usage for a prolonged period of time.
- Third, pre-pandemic studies show more remote work could result in more miles driven, as work-from-home turns into work-from-car.
At the same time, on the supply side BofA expects...
- government policy pressure in the US and around the world to curb capex over coming quarters to meet Paris goals.
- Secondly, investors have become more vocal against energy sector spending for both financial and ESG reasons.
- Third, judicial pressures are rising to limit CO2 emissions.
In short, demand is poised to bounce back and supply may not fully keep up, placing OPEC in control of the oil market in 2022.
“We believe that the robust global oil demand recovery will outpace supply growth over the next 18 months, further draining inventories and setting the stage for higher oil prices,” Blanch wrote in the note, in which he also significantly raised his price forecasts for average Brent Crude prices next year. "There is plenty of pent-up oil demand ready to be unleashed," he added.
While other market-watchers, from trading house Trafigura to Goldman Sachs have previously hinted that oil could reach $100 again in the right conditions, the prediction from Bank of America has been the firmest to date. If crude does return to triple digits, it will be the first time since 2014, before a flood of North American shale oil sent the market into a slump from which it has never fully recovered.
According to Bank of America, the immediate prospects for the oil prices are bright: Oil consumption will be bolstered next year as mass transit struggles to keep pace with extra travel demand, prompting passengers to make greater use of private cars. Even the ongoing popularity of remote working won't dent fuel consumption as much as expected, as home-workers use cars during the day to run personal errands, the bank said.
Even so, Blanch sees "ample spare capacity" setting a cap on oil prices in 2021: "It is no secret that the future direction of oil prices over the next 6 to 12 months very much relies on OPEC+ policy. After all, OPEC still has 8mn b/d of spare capacity (May) after multiple downward output adjustments. With OPEC crude production sitting at 25mn b/d (Exhibit 10) at present and the market poised to face a 1.1mn b/d deficit over the next 12 months, it would just take a Saudi or Russian change of heart to sink oil prices down from the current levels. Precisely because of this ample spare capacity, long dated crude oil prices have only climbed back up to $60/bbl or so, essentially the center of our long-term crude oil price band of $50 to $70/bbl (Exhibit 11)."
However, looking forward, Blanch concludes that a "combo of factors could push oil to $100/bbl next year":
The swift recovery in near-dated prices, coupled with a more measured upward drift in longer-dated oil prices, has pushed the crude oil market into a relatively steep state of backwardation. As deficits persist this year and next, we do not see any changes to this curve shape. If anything, OPEC+ could be tempted to test the limits of its supply policies in 2022. After all, the average OPEC+ fiscal breakeven sits over $70/bbl (Exhibit 12) and many of these oil producing nations could do with $80 or $90/bbl on the screen, even if just for a little while. If OPEC+ agrees to maintain the relatively tight supply policies of 2021 and 1H22 into 2H22 (Exhibit 13), we believe Brent crude oil prices could hit triple digits next year."
Of course, as oil bears know all too well, the best cure for soaring oil prices is soaring oil prices, which lead to a burst of new supply, and as Bloomberg notes the increasingly bullish outlook for oil is adding to pressure on the OPEC+ coalition led by Saudi Arabia and Russia, which meets next week to consider reviving some more of the production it cut during the pandemic. While Riyadh has signaled it prefers to move cautiously, an ever-tighter world market could compel the alliance to open the taps a little, especially with Russia increasingly voicing disagreement with the Saudi strategy.
Additionally, BofA warns that US shale supply "is likely to respond eventually to the more constructive oil price backdrop. Looking at US oil rigs and front-month contract oil prices, we note that there is a strong linear relationship that carries roughly a 3 month lag between prices and drilling activity (Exhibit 38). We have explained in our prior work (see All things thrive at thrice) that the price elasticity of shale supply has likely come down in recent years. Yet we also note that US tight oil breakevens have been falling for a long time (Exhibit 39). Lower breakevens have partly offset the reduced price elasticity of supply resulting for a string of negative price shocks in 2016, 2018, and 2020."
Put differently, BofA expects US shale to ramp up eventually in response to the crude oil higher prices... assuming the Biden Administration allows it. Should that happen, BofA expects the oil market to tilt from a deficit of 1.35mn b/d in 2021 into a surplus of 400 thousand b/d or more in 2023, but before that happens - assuming nothing else changes - first we need to hit triple digit prices, and it is this sweet spot that oil traders will be focusing on.
And while BofA's forecast may seem a little extreme, others expect even higher prices. David Tawil, president of Maglan Capital, told Fox Business last week that “incredible demand,” inflation, and shareholder pressure on oil supermajors to drastically cut emissions could lead to an oil crisis within three years, with very high oil and gasoline prices. Oil prices are set to rise “consistently and considerably now into the end of the year,” Tawil said.
Meanwhile, speaking at the FT Commodities Global Summit last week, top executives at Trafigura, Vitol, and Glencore said that although oil may not be headed to a new supercycle (Goldman and JPM disagree), prices still have room to rise from current levels because of a strong demand rebound and expected tightness in supply.