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Below the Quote on Oil by Norbert Rücker, Head Economics and Next Generation Research, Julius Baer 

OIL: SHORT-LIVED SENTIMENT SUPPORT?

Oil’s recent up move seems at odds with the outlook of surplus supplies. Globally soft demand, the petro-nations’ policy U-turn, and incremental growth from South America’s offshore platforms all point towards an oil market heading for abundance. Where do the tailwinds come from? The market mood had already been exceptionally depressed, and a new up-cycle seems in the making, likely lending tailwinds to prices. However, such support tends to be short lived. We believe that today’s oil prices above USD 65 are trading at the upper end of a fundamentally justified range.

The fundamental headwinds to oil prices seem well flagged and understood. The petro nations’ policy U-turn and the pledge to lift production restrictions swiftly by more than one million barrels per day should already be sufficient on its own to meet expected global demand growth. The incremental growth coming from the development of offshore resources in Brazil and Guyana, alongside the production growth witnessed elsewhere, should tip the market into a surplus later this year. Importantly, most of the trends and factors underlying this surplus are less exposed to oil price swings. The production growth comes from highly competitive resources where investment decisions were taken a while back. Oil demand is almost stagnant, partly due to the electrification of road transport and the shift from oil- to gas-based feedstocks in petrochemical production. This is particularly evident in China; however, electric vehicle sales have also regained momentum in Europe as of late. Why are oil prices up over the past days, despite these expected fundamental headwinds? The oil market mood, as measured by the futures positioning, has been exceptionally bearish more recently, and seems to have to begun recovering somewhat. There are signs of an up-cycle in the making; usually, such a sentiment swing lends tailwinds to prices, at least in the short term. This mood recovery was likely supported by better-than-feared economic data releases, wildfire-related production disruptions in Canada, and other events. However, with the petro-nations’ policy U-turn, the competitive dynamics in the oil business should pick up. The wrangling for market shares intensifies, capacities free up, and margins are pressured across different segments of the supply chain. The US will likely see its energy dominance peaking as drilling activity drops, output growth slows, and exports possibly decrease due to competitive forces heating up. In this context, we believe that today’s oil prices above USD 65 are trading at the upper end of a fundamentally justified range.

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