Two weeks into the new year and the script has already been torn up. Surging Omicron cases and record COVID infections were supposed to act as a brake on demand and hence prices. Instead, the price action has surprised to the upside as the impact of the new variant turned out to be less severe than initially feared. This sentiment was recently echoed by the head of the IEA. Fatih Birol acknowledged that global oil demand has proven to be more resilient to the effects of the Omicron variant’s spread than expected. The next edition of the IEA’s Oil Market Report is scheduled for release next week and is more than likely to contain some upward revisions to its demand projections.
Meanwhile, on the supply side, bullish sentiment has been underpinned by a host of short-lived supply disruptions. Yet a longer-term supply factor is now gaining attention, namely shrinking OPEC+ spare capacity. Yesterday, JP Morgan warned that OPEC spare capacity will decline through 2022 as it brings back curtailed volume. When you consider that OPEC+ is still nowhere near pumping to its overall quota, this narrowing cushion could turn out to be the most bullish factor for oil prices over the coming months.
The latest supply and demand dynamics suggest that the coming oil glut could be much smaller than expected at the end of last year. This, in turn, should limit the downside for oil prices. In the meantime, the oil market appears to have entered a holding pattern after a string of solid daily gains. Brent and WTI eased slightly in yesterday’s session as a bout of pre-weekend profit-taking took hold. Both crude markers are struggling for traction this morning amid downbeat Chinese data and look set to end this week on a subdued tone.
A golden year for US crude exports?
US crude exports closed out 2021 on the front foot. Shipments over the four-week period ending on December 31 averaged 3 mbpd. However, this strong finish couldn’t prevent exports from declining on an annual basis for the first time since the lifting of the 40-year-old export ban in 2015. They averaged 2.9 mbpd last year, down from a record 3.2 mbpd in 2020. Will US crude exporters make amends this year? Well, not if the performance in the first week of the year is anything to go by. Outbound US crude flows slipped below 2 mbpd to their lowest level since July last year in the week to January 7, according to the EIA. This, however, will most likely turn out to be a minor dip more than anything else. The fact is that there are several reasons to suggest that US crude exports are on track for a revival.
For starters, shipments will be buoyed by the recovery in US crude supply. The rally in oil prices and gradual recovery in global oil demand means that US crude oil production will grow from its current level. And sure enough, US oil producers are returning to the well pad with increasing vigour. US rig counts have been rising alongside oil prices. Baker Hughes reported the total oil rig figure stood at 481 last week, 194 higher than the rig count this time in 2021. The upshot is that the US is expected to be the world’s leading source of oil production growth in 2022. US crude production is forecasts to grow 640,000 bpd this year, after declining by 100,000 bpd in 2021, according to the latest EIA forecasts.
All the while, as more economies return to growth and demand reaches pre-pandemic levels, there’s space for further growth in US crude exports. Yet this will all count for nothing if it weren’t for a crucial piece of the jigsaw puzzle for the US crude export machine, namely supportive arbitrage economics. The Brent-WTI spread averaged less than $3/bbl last year but is currently printing above this level. This discount for benchmark US crude futures to the international marker Brent should make US crude-linked grades more attractive to foreign buyers. Looking ahead, the EIA expects this spread to remain above $3/bbl in the first half of 2022 before widening to a discount of $4/bbl in 2H22. Favourable price spreads should ensure US crude shipments remain elevated throughout the year.
So, US crude production and global oil demand remain on an upward trend. This makes for a positive backdrop for US crude exports. However, it must be said that there are some potential hiccups on the horizon. To begin with, US oil exporters will face increased competition from returning OPEC+ barrels. Yet as mentioned earlier, many members nations will struggle to deliver output increases. Meanwhile, on the demand front, the rumour mill is in full swing that China, the biggest buyer of US crude, could see slowing crude imports in 1Q22. A combination of Beijing’s policies to curb pollution in time for the Winter Olympics, its crackdown on illegal practices at independent refiners, and its zero-COVID policy with intermittent lockdowns are set to slow crude oil imports in the early part of 2022.
The final potential fly in the ointment is rapidly dwindling US crude inventories. Stocks are now at their lowest levels since October 2018. Should they continue to trend lower, the gap between WTI and Brent could narrow thereby undermining arbitrage economics and resulting in lower US crude oil exports going forward. For now, though, US crude oil export flows are on track to grow as global demand recovers. Better said, the US crude export machine is set to get back to its record-breaking ways in 2022.