Some say that the journey is more important than the destination and so it was with Brent’s ascent above $80/bbl. The European crude benchmark topped this psychologically important threshold yesterday for the first time in three years. Yet this milestone moment proved to be somewhat anticlimactic. No sooner had it scrambled past $80/bbl than a bout of profit-taking took hold. The upshot is that Brent eased back and eventually ended the session 44 cts/bbl lower at $79.09/bbl. Also spurring the pullback were concerns over the ramifications of an $80 oil environment on the global economy.

Even so, analysts believe oil will continue to rise as demand is strengthening and supplies remain tight. Indeed, major banks rushed to upgrade their oil price forecasts in the wake of Brent topping $80/bbl. Morgan Stanley claim that oil could reach $85/bbl in the short-term while Barclays upgraded its price outlook for 2022. For now, though, the oil market is coming under further pressure this morning after the API reported an unexpected uptick in US oil stocks last week. API data showed US crude stocks rose by 4.1 million bbls despite the continued production outages in the Gulf of Mexico. Meanwhile, gasoline and distillate fuels inventories rose by 3.6 million and 2.5 million bbls, respectively. The latest price pullback suggests pockets of worry are still present across the oil market.

Devil’s advocate

Energy markets are in overdrive and the bullish bandwagon is in full swing. While we don’t advocate swimming against the prevailing current, it is a worthwhile precaution to examine what could take the steam out of the current price rally. First and foremost is a mixed demand picture. Currently, the oil market remains well supported by demand in the US and Europe. The former is heading into the winter heating oil season whilst a gas crunch in the latter is expected to boost demand for other fuels including oil. But in other parts of the world, there is trouble brewing.

The World Bank recently said that the Delta variant is slowing economic growth in the East Asia and Pacific region. More importantly, concerns are growing about a bigger economic crisis in China. Needless to say, such an eventuality could put downward pressure on a lot of the commodities that the country consumes. The world’s second-biggest economy has been tarnished by the Evergrande fiasco and, more recently, an unfolding power crisis that poses a growing threat to its factories. Throw in a batch of downbeat PMI surveys and it comes as no surprise that both Goldman Sachs and Citi have recently cut their Chinese growth forecast. Simply put, China’s economic troubles are casting a dark shadow on the demand side of the oil coin and hence the price outlook.

Another pitfall of higher energy prices is that it will spur already-heightened inflation. Rising oil prices have been one of the biggest drivers of inflation. And a worsening inflationary situation will act as a drag on the fragile economic recovery and oil consumption. This brings us neatly onto the issue of demand destruction. The world’s top importers of crude oil appear to have become increasingly sensitive to rising oil prices. Earlier this month, China made the headlines after releasing some crude oil from its strategic petroleum reserve for the first time. India, too, is selling oil from its strategic reserve. The reason for this turn of events is price. At over $70/bbl, crude appears to have become too expensive for Beijing and New Delhi. Although this development has not impacted the global oil balance, it sends a strong message. Oil prices hitting $80/bbl will be a severe pain point for these key crude buyers and is likely to undermine import demand.

Turning our attention to the supply front, the major risk event for oil prices is a bigger-than-expected supply response from non-OPEC+ and none more so than US shale. Over the past 18 months, US shale players were forced by the pandemic and by their shareholders to focus on shoring up cash flows rather than chasing production growth. Now, though, producers are back in growth mode and output is creeping higher. The US oil rig count rose last week to a post-pandemic high of 421, according to data provided by Baker Hughes.  All the while, Primary Vision’s Frac Spread Count, which tracks the number of completion crews finishing off previously drilled wells, shows that completion crews rose by 8 to 252 for the week ending September 17. Most shale wells are profitable again at current prices and the sector’s revival could become a downside risk for prices before too long.

In contrast, OPEC+ is in no rush to push crude output towards pre-pandemic levels. The alliance is expected to loosen supply restrictions by another 400,000 bpd next week as per the current agreement. That being said, there will be concern among the ranks over the latest rise in prices. According to the Iraqi oil minister, the group is working towards keeping prices around $70/bbl. Therefore, if the current price strength continues, we could see the alliance deciding to an aggressively faster ramp-up in production by year-end. Russia, for one, is already showing an eagerness to bring back capacity. Its oil and gas condensate production is said to have risen to a post-pandemic high of 10.7 mbpd this month. All the while, it hiked its 2022 oil output target. In short, the potential for a swifter-than-expected return in OPEC+ supplies cannot be discounted. Yet even after examining the aforementioned bearish catalysts, the odds are that oil prices will remain well supported in the coming months. After all, global oil supply is unlikely to overtake demand in the year-period.