Draw the line here: oil demand is never linear

It’s always fun to read analyst notes on the seller’s side to the extreme, the mere sensationalism of events becomes almost self-fulfilling as it forces others to follow suit, lest they be left behind.

This is what is happening in the oil markets, right now, one by one, each auction house is asking for between $ 90 and $ 100 a barrel. Brent oil, some even say, could reach $ 120 a barrel. The desperation and fear in the ratings is almost synonymous with that seen deep in the COVID crisis last year when WTI plunged to -35 $ / bbl.

Do we feel a theme?

The supply side is very easy, or rather simpler, to predict, because it is the “known”. Projects don’t happen overnight and most companies are generally quite transparent about their drilling plans. The capacity of the larger state-owned producers is also known, their theater and games may be more difficult to predict, but at the end of the day it’s all about budgets, revenues and economies of scale. The hardest thing to predict is demand. This is because it never remains constant. We have seen how demand swung violently in 2020, going from 1.5% to -10% and now up 5%. Oil is a commodity and it is cyclical, more importantly, it is seasonal.

What happened in 2020 was exceptional. Oil prices turned negative because physically the oil could not settle in a short period of time. This is how raw materials work. If you have too much, there is no floor value, and if you have too little, you will pay infinitely even (electricity and power recently). The surge in demand last year and this year has also been exceptional given the amount of money pumped into the economy by central banks, as well as the announced fiscal policies. The combination of the two caused a massive increase in M2 money supply, by around 25% year-on-year. This is an increase of 40% over the past two years, the largest increase in two years dating to 1959. This is not normal. The surge in demand seen for raw materials and products is not something that can be repeated, let alone predicted.

There is undoubtedly a shortage and a shortage in some products and products. This is evident in the delays in containers and ports, the narrowness of the supply chain and the price of each product and a good increase, given the push in a very short period of time. But as we learned from Economics 101, what happens when prices start to climb to infinity or supply falls short, we start to see demand destruction. This is the only solution before the offer has time to catch up. Finally, one side always gives way.

Global oil consumption has rebounded a lot, but is still a little lower than pre-COVID levels, but what most don’t talk about is global production. It’s still well below pre-COVID levels. There has never been a shortage of oil, look at 2014 and 2018. In fact, producers are holding back and keeping barrels out of the way to keep the market going ever since to keep it “balanced”. U.S. shale has lost about 2,000 barrels per day (mbpd) of ongoing oil production since COVID and U.S. producers have been slow to restart it, given their wrists slapped by their investors, even though these prices have great economic sense. This is a window of opportunity for OPEC + to really “maneuver” the market as they are literally the producer of swing.

It’s been a year and a half since the onset of COVID, and the economy is running at full speed, prices have skyrocketed even before cycle highs, and yet they fear demand is not strong and are deliberately slowly releasing all of them. the 10 mbpd of oil they took off last year on the market. Why the rush, when higher prices mean more money for them? Especially if the trend is gradual.

There is a risk that if demand remains as strong and producers hold back, the OPC + will hold back all the oil and we also get a cold winter, prices may rise higher. But there are a lot of ifs in this sentence. This is the basis of the notes we have seen predicting the same stable growth in oil demand assuming there will be no destruction or slowing in demand after all the stimulus-induced expansion. . From this point of view, of course, oil prices can skyrocket. But time and time again we find that when demand slows down and prices start to drop, then they will reduce their demand and demand lower prices, after the fact of course. Rinse and repeat, the process starts again.

It’s easy to see the extremes at both ends, but the real analysis depends on what the future demand equation will be. This is where most academic institutions and analysts lose out because their job is not to predict or make a call as such. They are like the Fed, they only react to a certain set of conditions after it happens. We all know markets don’t work that way.

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Steve R. Hansen

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