A well-publicized increase in oil output is usually the harbinger of softer prices, yet the latest announcement from OPEC+ to continue easing production constraints has been met with a very impressive price rally over the past two days. Such is the enthusiasm that not even an awfully bearish weekly stock data was able to halt the jump higher – at least for now.

Total commercial oil inventories swelled by 10 million bbls despite crude oil stocks dipped 2.1 million bbls. Dwindling proxy demand (-2.6 mbpd last week) led to sharp increases in gasoline (+10.1 million bbls) and distillate (+4.4 million bbls) stocks. Yet, what we saw was a convincing jump in prices. Not only flat price strengthened but the front-end structure of both crude oil futures contracts saw increased buying interest, even though Cushing stocks were up 2.6 million bbls. Heating Oil spreads have also rallied of late. It appears that investors viewed the disheartening reading as the unavoidable but temporary price paid for the spread of Omicron, which will not have a long-lasting impact on the US oil landscape.

Instead, they have focused on bullish developments and there have been a few of those lately. On top of recent production problems in Libya US products received a boost from Exxon’s part closure of its 580,000 bpd Baytown, Texas refinery due to a blast just before Christmas. Repairs will reportedly take up to 8-12 months with 30% of the operation impacted resulting in a loss of around 90,000 bpd of gasoline and 80,000 bpd of distillate output.

Further support came from the Central Asian OPEC+ member, Kazakhstan where protests against a drastic rise of LPG prices turned into an anti-government demonstration and forced the ruling party to declare a state of emergency in major towns. Oil production has been unaffected so far, nonetheless rising tension has been a morale boost for buyers.

The fact that the some of the gains were erased towards the close shows that the supportive factors could disappear soon. The latest Fed minutes from December 14-15, which implied an earlier-than-expected rate rise also helped oil retreat as equities fell. In the unlikely case of the market proving resilient bears can rest assured that with WTI close to $80/bbl and US domestic pump prices still well over $3/gallon the White House will soon pressure OPEC+ again to raise output faster than planned.

Demand growth does not equal higher prices

It is now almost an axiom that the coronavirus will be soon beaten after a lengthy war against the pandemic. There might still be ups and downs, but health experts are growing in confidence that the widening roll-out of vaccination programmes and natural infections will soon reduce the impact of Covid to a flu-like illness that will not disrupt everyday life to the same extent as it did in 2020 or 2021. Mitigating the negative effect of the virus will naturally lead to economic well-being and healthy oil demand growth. This school of thought is reflected in this week’s OPEC+ meeting and the considerable improvement in global oil demand. One of the reasons cited by the producer group to continue with the tapering of output restriction is the expectation of minimal economic damage caused by the Omicron strain. Indeed, last month’s reports on oil balance suggest a sizeable increase in global oil consumption in 2022. Forecasts range from 3.35 mbpd (IEA) to 4.16 mbpd (OPEC) with the EIA in between with an estimate of 3.55 mbpd.

Should oil bulls pop the cork on the champagne as the world will likely need at least as much oil this year as in 2019? Well, they would have done it the past, but it seems premature this time. There used to be a very measurable relationship between global oil demand and annual average oil prices. To put a number on it, between 1994 and 2014 this correlation stood over 95%; the higher demand growth, the stronger prices and vice versa. This relationship started to sour with the emergence of the US shale industry. That was the time when LTO production broke over the 5 mbpd marl (it was hardly above 2 mbpd just three years before) and jumped above 9 mbpd by the end of 2019. The increasing role US shale output played in the global oil equation occurred at the expense of OPEC. The organization was responsible for around 35% of the global supply before 2015. Its share has gradually shrunk and fell to 29% in 2019 and 27% in 2020 (admittedly, partly due to the massive voluntary output cut in the latter year). OPEC, whilst still a force to be reckoned with, has been losing influence. At the same time, the correlation between consumption and prices has also deteriorated and is now around 50%, hardly a useful barometer in predicting future oil prices.

If not demand, then what? When searching for clues it only makes sense to examine the connection between oil prices and stock levels – OECD inventories, that is as data on global oil stocks is difficult to obtain. It shows a high inverse correlation of around 80%. Of course, this method is not fool proof, but it provides an invaluable helping hand and it did work last year. The combination of recovering consumption and the OPEC+ output agreement led to the depletion of oil stocks in the developed part of the world and oil prices significantly rallied year-on-year.

Coming from this angle, the first half of this year does not augur well for oil bulls. As the producer alliance follows the roadmap laid out in 2020 global oil supply is set to exceed demand in coming months. The natural consequence of this oversupply is a rise in global and OECD inventories. The latter finished last year at around 2.75 billion bbls and based on latest available data is poised to increase to around 2.85 billion bbls by June 2022. Using historical data these figures imply that Brent should average between $70 and $75/bbl in the first six months of the year. Beyond that the call on OPEC is expected to rise once again and the producer group will probably reach its limit to increase production meaningfully above 30 mbpd resulting in stock depletion and strengthening prices towards the year end sending Brent permanently above the $80/bbl mark. This prognosis would probably be upended in case Iran strikes a deal with the US and re-enters the export market or if the pandemic proves much more resilient than currently anticipated abruptly destructing oil demand.