The new year kicked off in an eventful and optimistic fashion. Both equities and oil edged higher despite the continuous surge in Omicron cases. In the US flight cancellations prevent employees from returning to work after the festive period, in the UK the prime minister warned of growing pressure on the health service but insisted that no new restrictions are necessary because the new strain causes milder symptoms than the previous variants. Scientist are getting more optimistic, too. Despite the fast transmissibility of Omicron there is a growing consensus amongst health experts that increased immunity through vaccinations and natural infection will considerably mitigate the impact of the virus in coming months.
Wall Street helped oil regain its footing after last Friday’s long liquidation. Equities were supported by Apple and Tesla. The maker of the popular hand-held device hit a market capitalization of $3 trillion whilst the shares in Elon Musk’s company rallied more than 13% due to better-than-expected quarterly deliveries weathering chip shortages. Asian stock markets are following through this morning supported by a positive reading on China’s December factory activity.
Whether the current enthusiasm can be maintained is questionable. Haitham al-Ghais, OPEC’s newly elected secretary general, who will replace Mohammad Barkindo in August made it clear that his priority will be to keep the OPEC+ production agreement in place. Today’s ministerial meeting is expected to be a formality as the energy chiefs of major oil producers will likely rubber stamp another 400,000 bpd monthly increase for next month. As discussed below, the global oil balance will, in all likelihood, flip into surplus soon and the current upbeat mood should sour in the near future.
Uncertainty lies ahead
Any seasoned chart analyst would tell you that markets move in trends. These are categorized as uptrend, downtrend, or sideways market. They would also rush to emphasize the adage, namely that the trend is your friend. It means that the prevailing market sentiment is more likely to continue than reverse. This observation is statistically accurate and in case it proves to be true for 2022 bulls will have another field year. However, ominous hints started to emerge towards the end of last year that signalled potential struggle to maintain the prevailing optimism, especially in the first half of the new year. We have summed up the main geopolitical, economic and oil developments of 2021 in yesterday’s note. We will stick to the same script below as we look ahead to 2022.
Geopolitics: one of the major issues of the new year is whether the simmering tension between Iran and the US will escalate or Western powers will manage to salvage the 2015 agreement, which Donald Trump abandoned. The signs are not encouraging. Iran is now enriching uranium that is dangerously close to weapon-grade levels. Whilst it claims its nuclear programme serves peaceful and civilian purposes an eventual flare up in tension between the Persian Gulf OPEC member and Israel could easily make the return to the original accord nothing more than wishful thinking. The next round of talks started yesterday in Vienna and will undoubtedly drag on for months under the watchful eyes of the oil market.
Relationship between Russia and the West is at its lowest level. The alleged threat to invade Ukraine has been met with harsh rhetoric from the US and its allies. The situation is so tense that two Scandinavian nations, Finland and Sweden, are openly contemplating joining NATO, a step, which would force Russia to “retaliate militarily”. In case of further escalation and new sanctions imposed on Russia natural gas can be once again used as a weapon. China’s sabre-rattling about Taiwan looks like a demonstration of power, which is unlikely to lead to an invasion as the subsequent economic sanctions could easily cripple the Chinese economy.
Global economy: in a way, the global economy is the victim of its own success. Assorted stimulus schemes started the recovery from the pandemic-induced devastation but at the same time it triggered persistent inflationary pressure because Covid-related supply chain bottlenecks aided prices climb higher throughout 2021. Policy makers were forced to act. The beginning of the new year is expected to bring with it tighter monetary policies that will manifest in halting of bond-buying programmes and/or raising interest rates as already indicated by the Fed, the ECB, the BoE and the BoJ in order to avoid stagflation. With rising borrowing costs aggregate demand will suffer and this might just cap further stock market rally, especially in the first half of the year.
The US midterm elections in November will also be eagerly watched. Democrats have a razor thin majority in both the House of Representatives and in the Senate. With Joe Biden’s approval rating close to its lowest there is a good chance that Republicans will take back both chambers of the Congress dealing a significant setback to the administration’s ambitious economic programmes.
Oil: in addition to the impact of the coronavirus on oil demand the output policy of the OPEC+ coalition will be the main driving force of oil prices this year. After successfully bringing global oil inventories lower in 2021 OPEC+ seems to employ a more relaxed approach in 2022 by insisting on increasing production by 400,000 bpd per month in the foreseeable future. This might be partly due to the pressure from the US to bring prices down. Latest OPEC data suggests that a global oil demand growth of 4.16 mbpd in 2022 will be coupled with an increase of 3.02 mbpd in non-OPEC supply and possibly a year-on-year jump of more than 3 mbpd in OPEC output, the lion’s share of which is concentrated in 1H 2022. Excess supply together with potentially lukewarm equities could prevent oil from gaining significant ground at the beginning of the new year. Maybe this is why the structure of the ICE Brent contract has weakened significantly over the past two months. A brief dip into contango cannot be excluded in coming months.
The fight against climate change and global warming will not have a meaningful impact on the oil balance this year. Systemic and behaviour changes and further technological advances incentivized by government actions and inter-governmental cooperation are needed in order to phase out the use of fossil fuel in favour of renewable energy. But these changes are not imminent and they might not happen before a supply crunch in 2-3 years’ time. Until then, oil will remain a dominant source of energy.
This is, however, a topic for January 2023 or 2024. As for the incumbent year, both the stock and the oil markets should take a breather as inflation is tamed and supply exceeds demand. We are still of the view that the war against the pandemic will end in an obvious victory which will be the catalyst for higher stock equity and oil prices. Nonetheless, the resumption of the move higher is only expected after a few months of static-to-slightly-lower price levels.