Oil price would be higher for longer

The break-even points of most US oil producers are only US$30 to US$50 for WTI oil 


HIGHER price environment favourable to oil companies; oil demand to remain stable

West Texas Intermediate (WTI) oil price had dropped from over US$110 (RM493.90) to US$80 per barrel. Compared to the 2015- 2021 period, the WTI oil price at US$70 level was already very high. The break-even points of most US oil producers are only US$30 to US$50 for WTI oil. The higher price environment is very favourable to oil companies at this stage. 

Oil demand remains at around 100 million barrels per (MMbbl) day and is expected to remain stable. There is no evidence that oil demand is in structural decline. Demand destruction does not occur while the relatively high oil price environment persists since early 2022, which reflects a certain degree of stickiness in oil demand. 

Due to long-term underinvestment, difficult for oil prices to fall significantly

The capital expenditures (capex) by global upstream oil and gas (O&G) producers remain at a lower level in the past decade. The prolonged underinvestment in the industry gradually impacts the supply side. Despite a gradual increase in their capex in recent years, they are still restrained in increasing production and investment after the oversupply caused by the 2012 US shale oil revolution and negative oil prices in 2020. A slow or even no production growth would support the oil prices and prolong the upward cycle of oil prices. With long-term underinvestment and supply constraints, it is difficult for oil prices to fall significantly. 

Based on Bloomberg, some of the top oil companies such as (like ExxonMobil Corp, Chevron Corp and BP plc) would have better profitability and cashflow in 2022, compared to 2014 (when oil prices were last high), but they would invest less in capex. On the other hand, with oil companies continuing to “lay flat”, we can expect the tighter supply to continue going forward. 

OPEC+ might face prolonged period of underinvestment

On the other hand, OPEC+ might also face a prolonged period of underinvestment. Since January 2021, OPEC+ frequently experienced lower actual outputs than Output Targets. The output gap in 2022 was even more severe under the high oil price environment, which was against common sense. 

In general, OPEC+ countries tend to produce more in a high oil price environment, in order to increase their fiscal revenues. But the actual result often ended up with output shortfalls, not to mention the Output Targets already lowered by OPEC+ a few times. As such, we believe that OPEC+ might also face the dilemma of limited production growth due to years of underinvestment in the past. 

In addition, OPEC+ hopes oil prices to remain high (above US$90 per barrel for Brent crude) and might push the price up by cutting production or lowering targets, which also provides strong support for oil prices. 

US inventories not sufficient; replenishing oil reserves lead to difficulty in oil prices to fall further

Starting in May 2022, in response to high inflation, the US would release 1MMbbl (about 1% of global demand) from its strategic oil reserves for consecutive six months. After OPEC+ announced a production cut, President Joe Biden changed the original October halt in reserve releases, and released another 10-15 million barrels in November. 

On top of that, US strategic oil reserves fell sharply to approximately 370 million barrels (as of January 2023), resulting in insufficient local inventories, with a nearly 40-year low in total crude oil inventories. In addition, the sudden increase in market supply at that time distorted oil prices in the second half of 2022. 

But ironically, due to the lack of local inventories, Biden said he would replenish oil reserves below US$67-US$72 WTI, which will give oil prices support in these price ranges. It is difficult for oil prices to fall further. 

Russo-Ukrainian war had limited impact on oil supply for the time being; subsequent impacts might not be priced in oil prices

The market generally believes that the war between Russia and Ukraine is the main reason for the current high oil prices. In fact, the Russo-Ukrainian War had limited impact on the overall oil supply for the time being. Russia is still producing a lot of oil. On the contrary, the Russo-Ukrainian War exposed the problem of the energy shortage in Western European countries, leading to an energy crisis. 

If we compare the production before and after the war (before the war: January 2022; after the war: September 2022), Russia’s daily oil production only dropped by 3.5% (390,000 barrels), accounting for only 0.4% of the global production. The impact is really limited. Therefore, even after the end of the Russo-Ukrainian War, we expect a low chance of a large decline in oil prices. 

China and India do not mind importing oil from Russia, so Russia can export most of the oil, which cannot be exported to Western European countries, to China and 

India, even if there is a boycott of Western European countries. Besides, it is difficult for Western European countries to replace their energy dependence on Russia simply by being self-sufficient or significantly increasing oil imports from other countries. As such, Russia’s oil production only slightly decreased, an embarrassing situation. 

The European Union oil embargo on Russia and the imposition of a price ceiling on Russian oil (initially at US$60 per barrel) are effective since December 2022. These are not yet fully priced in the oil prices. It is estimated that around two to 3MMbbl (around 2% to 3% of global production) of Russian oil supply will be affected when the embargo comes into effect. If Russia does not have ways to redirect these sanctions-affected oil to other countries or if Russia just simply cut the oil supply, oil prices might rise again. 

Bullish on oil prices to remain higher for much longer; oil producers would benefit

Looking forward, on the demand side, China’s city lockdown measures were relieved. It would increase energy consumption in the short-term. The supply of renewable energy is not sufficient to replace fossil fuels in the short-to-medium term. Denuclearisation of some European countries is expected to bring them back to fossil fuels. Long-term developments in developing countries (eg India, with a population of about 1.4 billion) will also drive demand for oil. 

Besides, there are a number of structural issues on the supply side, including: 1) The prolonged underinvestment in the sector resulting in capacity constraints; 2) oil producers’ “lying flat”; 3) many governments in Europe and US discouraging oil exploration activities and infrastructure investment, and the climate change and environment, social and governance concerns related to fossil fuels posing pressure on oil producers, leading them to being cautious in ramping up oil production. These factors cannot be solved overnight. Thus, we expect oil prices to remain higher for much longer. The upstream oil producers would continue to benefit. 

  • The views expressed are of the research team and do not necessarily reflect the stand of the newspaper’s editorial board. 

  • This article first appeared in The Malaysian Reserve weekly print edition