The oil market is unbelievably resilient, and bulls are in full control. There seems to be a widely held view -actually it is more of a conviction- that the supply deficit that characterized 2021 will continue undisturbed this year. The latest leg up that started pre-Christmas based on mild symptoms of the Omicron variant accelerated at the beginning of the new year due to a rise in geopolitical risk premium. Cold winter in North America is also seen as a supportive factor. The Heating Oil/WTI crack spread that was around $22/bbl before the festive season is now well above $26/bbl. The structures of WTI and Brent have both strengthened considerably. The backwardation between the first and the sixth week of the Brent CFD curve is more than $1.80/bbl – the physical crude market is way over the forward or futures contracts. It implies genuine prompt tightness.

Inflation does not seem to be a concern or if it is then it is also a supportive factor because oil is used to take advantage of inflated prices. US December consumer prices soared 7% year-on-year and the dollar weakened – another layer of support yesterday. Bond yields are rallying and because interest rates are still low real yields are attractive therefore investors migrate funds from stocks to bonds. The Fed is expected to start putting interest rates up as early as March to make lending more expensive hence denting the rise in aggregate demand. Yet, oil refuses to budge. The talk of $100/bbl is getting louder by the week.

Not even a tepid US inventory data is able to spoil the party. Although crude oil inventories dropped more than anticipated (-4.5 million bbls including -2.5 million bbls at Cushing, Oklahoma) the combined build in gasoline and distillate was 8 + 2.5 = 10.5 million bbls. Products supplied by refiners, the proxy for domestic oil demand, did not nosedive but did not swell either – it is stable around 20 mbpd.

As discussed below, the EIA expects an increase in global oil inventories this year. The forecast goes in the face of the prevailing market sentiment and belief. The current rally is being mainly led by the US – WTI’s discount against Brent is getting smaller and the premium Heating Oil commands over ICE Gasoil is growing. CME natural gas has gained 35% in less than two weeks. One cannot help but think that the major driving force behind the current rally is the winter in North America. It will be interesting to see if the optimism is maintained when temperatures start rising come spring. Until then, as the adage goes, the trend is our friend.

Stock builds in 2022

There are two developments that catch the eye in the latest Short-Term Energy Outlook released by the EIA on Tuesday evening. The first one is that global oil demand is expected to hold up well in the first half of the year and throughout 2022. The second one is that non-OPEC supply will not be as encouraging as previously estimated. Consequently, the call on OPEC has climbed.

First, demand. It will be steady and resilient this year. The EIA has revised it upwards by 125,000 bpd for the first half and by 60,000 bpd for the full year. It appears, that the health crisis will not have a negative impact on global consumption, which will average 100.51 mbpd in 2022 and will reach 101.33 mbpd by the fourth quarter of the year. These are the highest annual and quarterly readings. The annual demand growth is projected to be 3.61 mbpd after rising just over 5 mbpd last year. The main pillars of this growth will be gasoline, diesel and hydrocarbon liquids. It will not come as a surprise that the non-OECD region will be responsible for 2.2 mbpd for the total increase with the balance occurring in the developed part of the world.

Non-OPEC supply estimates, on the other hand, have been amended downwards by 260,000 bpd for 2022 and by the same amount for the first half. Non-OPEC supply is now seen growing by 2.84 mbpd as opposed to 3.55 mbpd estimated in December. The US and Russia will be responsible for the lion’s share of this growth followed by Brazil, Norway and Canada. In the US an annual contraction of 140,000 bpd in 2021 will be followed by an expansion of 640,000 bpd. The EIA expects Russian oil output growth to slow down as last year’s constant increase of OPEC+ output has significantly eaten into the country’s spare capacity. In Norway the Johan Sverdrup oil field will remain the main source of growth, in Canada the expansion of the Enbridge Line 3 crude oil pipeline will support domestic production and output in Brazil should reach 4 mbpd this year after a Covid-related contraction in 2021. OPEC’s production, albeit surrounded by substantial uncertainty due to unpredictable demand considerations and limited spare capacity, is projected to rise from 26.27 mbpd last year to 28.76 mbpd in 2022.

The good news is that because of the changes both on the non-OPEC supply and global demand sides the call on OPEC will increase from 27.64 mbpd to 28.23 year-on-year (and to 28.23 mbpd in 1H 2022). The bad news is that rising OPEC production will exceed the growth in OPEC call, therefore both global and OECD inventories should start building this year, based on EIA numbers. The latter finished last year at 2.694 billion bbls. It should climb to 2.773 billion bbls by June 2022 and to 2.809 billion bbls by the year-end. The estimated rise in global oil inventories should act as a break on rising prices but there are so many “known unknowns” that need to be dealt with (healthy economic growth leading to underestimated demand, overcompliance of OPEC+, rising financial demand as a hedge against inflation, geopolitics, amongst others) that the global oil balance is likely to be constantly revised leading to increased volatility.

Finally, it is worth looking at the first 2023 estimates. Global oil consumption is anticipated to rise to 102.27 mbpd reaching a fresh record high of 102.60 mbpd in 3Q next year. The year-on-year growth will be 1.75 mbpd, 100,000 bpd higher than the increase in non-OPEC supply. Demand for OPEC oil will be slightly higher next year than in 2022. It appears the rise in global oil demand will continue unabated despite the transition away from fossil fuel and limited spare capacity making the oil market prone to adverse price movements in years to come.