June 25, 2021 | 15:18
Is Crude Oil Ready to Crack $100?
As we have repeatedly stated since late last year, crude oil’s remarkable recovery continues. With WTI piercing US$70/bbl, the chatter of $100 oil has picked up steam. Moreover, the surge in prices should make things easier for OPEC+ at its Ministerial Meeting on July 1, when it will decide on its production cut strategy from August onwards. Note that OPEC+’s total production cut target is set to fall to 5.8 mb/d in July.
Beyond higher-than-expected prices, we think another key development that is working in OPEC+’s favour is the fact that the recovery in U.S. crude oil production has remained muted to date. U.S. output has averaged around 11 mb/d over the past year, except for a sharp drop during the Texas blackouts in February, compared to the pre-pandemic level of 13 mb/d. There appear to be three key factors holding back production: (1) Biden’s efforts to tackle climate change; (2) the acceleration in ESG considerations; and, (3) ongoing shareholder demands for capital discipline. Of prominence, Biden’s climate change agenda, which includes stricter regulations (for methane leaks and wastewater) and the removal of various subsidies, is raising the cost of extraction and investment uncertainty. Further, the combination of rising ESG and shareholder demands is also making it increasingly difficult for shale production, which requires continuous investment, by limiting access to finance. Thus, the magical $60 number—often cited as critical to catalyze new incremental production—has likely risen.
However, we wonder if OPEC+ would be truly comfortable letting crude oil prices run significantly higher despite the obvious economic benefits of greater export dollars and fiscal revenues. Indeed, crude oil prices, if sustained, have already reached levels that would push many key OPEC+ members’ budgets back into surplus. The IMF last estimated that the breakeven oil price for Saudi Arabia’s budget is set to fall to US $66/bbl in 2022 (vs $76 in 2021). Letting oil hit $100 or $90, particularly on a sustained basis, would also surely increase the viability of some U.S. production shut in last year. Moreover, there is the risk that higher prices could fast-forward the move to renewable energies (i.e., electric vehicles). As a result, there is a possibility that OPEC+ could begin to unwind its production cuts a little more aggressively despite a potential return of Iranian production.
Bottom Line: We are revising up our forecasts for WTI to average US$65/bbl in 2021 and $70 in 2022 (previously $60 for both years) due largely to OPEC+’s ability to restrain supply and rebalance the global oil market. This is not to say prices cannot head higher, especially given the tendency of commodities to overshoot, but we think such an event will prove to be temporary.