By Giles Coghlan, Chief Market Analyst, HYCM
It would be something of an understatement to suggest that the oil industry has experienced significant upheaval since the start of the year. Indeed, the oil markets have seen unprecedented levels of volatility as the conflict in Ukraine threatens supply and increasing worries about a global recession strangles demand. Because of this, prices have been incredibly volatile, occasionally climbing beyond $100 before dropping back down. As a result, Investors are finding it difficult to trade oil in the short-to medium-term.
However, despite obvious short-term factors, such volatility has become symptomatic of an industry that has been rocked by volatility for a sustained period of time. Therefore, it would be unsurprising to find that many investors are questioning whether oil investments still hold the same value and efficacy that they used to.
That said, OPEC+ decision on the 5th of October to cut supply from November will almost certainly have an impact on the markets and should keep prices at an elevated level towards the back end of 2022. Supporting this, it has been suggested that continued underinvestment in the hydrocarbons sector, coupled with measures for a green transition and shifting government regulations, could result in a mismatch between supply and demand. We should see prices shed some of their volatility and grow as a consequence, encouraging investors to maintain their faith in oil in the long-term.
As always, there are opportunities for investors in the oil sector, but they must be aware of the factors that could influence both the short- and long-term performance of the industry.
Assessing the short-term prospects for oil
As with any commodity, the price of oil is largely determined by simple factors like supply and demand. However, as prices are determined in futures markets, global economic activity is an equally important determinant. Therefore, given the looming global recession, we should expect oil prices to dip and remain at a lower level for the foreseeable future.
The conflict in Ukraine has had a significant impact on oil prices this year. Since the beginning of the crisis, prices have increased dramatically while also fluctuating drastically. To illustrate, at the start of the year, the price of oil was $52.2 a barrel. After the crisis started in February, prices spiked to $110/bbl. They then again reached a record high of $139.13/bbl.] on March 7 when the Biden administration made the importation of Russian oil exports illegal. At the time of writing, prices have, however, once more plummeted sharply, approaching $88 per barrel. Sanctions have hampered Russian oil shipments, which make up 12% of the global supply, resulting in a decrease in supply and an increase in price.
But falling demand has also had a substantial impact on price volatility. For instance, in mid-March, when China, the largest oil importer in the world, introduced stay-at-home orders in response to a fresh influx of Covid-19 cases, prices once again dropped below $100/bbl. To make matters worse, additional public health restrictions put in place at the start of September caused an additional decrease of 3%. As a result, the Chinese economy is experiencing a significant slowdown as a result of the shutdown of some of the country’s largest ports, thus harming demand.
Away from China, hopes for economic activity elsewhere are slowly diminishing. With the UK and Europe expected to enter a recession before the end of the year, and the USA set for a downturn in 2023, consumer spending on oil-related products and services (e.g. car fuel or air travel) is likely to take a significant hit, pressuring demand even further.
As such, the short- to medium-term did not hold much promise for oil investors…until this week.
This week, OPEC+ members voted to reduce their production of oil by up to 2 million barrels a day, removing a significant amount of supply from the global market. As such, with Russian exports still outlawed or capped in much of the West and gas supplies waning across Europe, this decision could lead to a considerable increase in demand. Consequently, towards the end of 2022, the narrative has shifted on the price of oil, with many in the investment world increasingly expectant of higher prices in the markets.
Therefore, there is light at the end of an incredibly volatile and unstable tunnel for investors in the oil industry.
Looking to the long-term future
Supporting this, in the long term, investors should feel a little more optimistic about the performance of oil. Due to government regulations and the transition to more renewable forms of energy, investments in the oil industry have been less than appealing for some time. As a result, the industry is beginning to encounter some structural problems, which should lead to future price hikes.
For instance, such a scarcity of investment is occurring at a time when rising supply is required to handle a growing energy crisis, raising the possibility of future energy scarcity. Energy markets were already in trouble before the conflict in Ukraine, as supply chains continued to fail, and demand rose as the world continued its post-pandemic recovery. These issues – such as a lack of spare production capacity or depleting commercial and strategic stockpiles – have not gone away. Therefore, demand should supersede supply, forcing prices to increase again.
Moreover, once the global economy rebounds post-recession in 2023, we should see an uptick in demand for oil that will lead to further increases in prices. Supporting this, the International Energy Agency has recently projected that demand for oil will increase by 2.1 million barrels per day (mb/d) to an unprecedented high of 101.8 mb/d next year. Therefore, even though the global recession may pressure prices for the remainder of this year, the long-term future should be of some encouragement to investors, as demand will always be high.
For many investors, it will seem as if global oil markets are in a constant state of flux. Indeed, this year has been particularly volatile, so its difficult to predict with any certainty how things might change or how prices might react to future geopolitical events. However, if investors remember that demand will start to outpace supply as the global economy recovers and the markets begin to feel the pinch of OPEC+’s decision to cut production, it’s clear that there are still opportunities to be had in the long-term future.
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