EFG International : Oil market at a crossroads

After President Putin's declaration of support to the separatist recognizing two separatist republics of Donetsk and Luhansk in Ukraine's east, the oil price has returned close to USD100/bbl (per barrel). Many observers expect the price to rise further and approach the highs reached in 2008 before the collapse of Lehman Brothers. The oil price rise, which has been ongoing since early 2021, is due to three main factors: stronger demand, weaker supply and geopolitical tensions.

Looking ahead, it is worrisome that in several countries, including Angola, Mexico and Nigeria, the estimated sustainable capacity is lower than the January production targets. Nonetheless, the IEA estimates the overall spare capacity of OPEC+ at 6.4 million b/d compared to January output, concentrated in Saudi Arabia, the UAE and Iran, the latter not subject to quotas but to sanctions that limit its exports. This makes it possible that OPEC+ production increases in 2022 but it will mean that countries with spare capacity will be required to take on most of the burden. Under normal circumstances, this would lead to a fall in the oil price, but the outlook for global energy markets is today highly uncertain.

This is in no small part due to the ongoing Ukrainian crisis that has recently helped push up prices and kept natural gas prices high. There are fears that Russia will mount a full-scale invasion of Ukraine and that the West will impose harsh sanctions that could limit, if not completely block, imports of oil and natural gas from Russia. In the most extreme case, OPEC+ and other producers' spare capacity would be insufficient to compensate immediately for the demise of Russian oil and natural gas.

What scenarios are there for the oil market?

The outlook is more uncertain than normal due to increased geopolitical risk and supply side developments. In the base scenario, oil production increases as projected by the IEA lead to a moderate supply surplus in 2022 and 2023. If this were a good guide to future outcomes, our model forecasts the WTI oil price to gradually decrease towards USD70/bbl, a little below what is incorporated in the prices of oil futures contracts.

If there is an escalation of the crisis in Ukraine resulting in a shortage of energy due to an embargo on Russian exports of oil and natural gas, the WTI oil price could rise above USD180/bbl. In this case, the consequences for economic growth would be meaningful and negative, especially for the European Union which is highly dependent on Russian energy imports.

Conversely, if diplomacy eventually prevails and OPEC+ countries comply with their production targets, the oil market will see a moderate supply surplus in 2022 and 2023. In this scenario, the WTI oil price is forecast to fall towards USD70/bbl over the next few quarters.