Telemus Weekly Market Review July 4th - July 8th, 2022
Over the past month, volatility has set in on the oil market, with the price of crude oil gyrating and falling from a price of $122 to low of $99 set earlier this week. During 2022, the price of oil has been influenced by the Russian invasion of Ukraine alongside inflationary pressures. While our pocketbooks hope these elevated prices are temporary, our assessment of the supply and demand dynamic around energy prices suggest that the price of oil may remain elevated for some time.
Worldwide demand for oil is 100 million barrels a day. Global supply is projected to meet demand in 2022, thus it also sits at 100 million barrels a day. Global production is widely dispersed, with the United States being the largest producer at 12 million barrels a day. OPEC, which has historically had a significant impact on oil markets, represents roughly a third of the global supply.
In 2021, worldwide production was below that of consumption. As a result, inventory levels were reduced in order to meet demand. At present, U.S. crude inventories are below historic ranges because of reduced drilling and production. The Energy Information Agency projects that in 2022, production and consumption (or supply and demand) will come back into equilibrium, with the prospect for production to mildly outpace consumption in 2023.
What is unique to the current environment versus past cycles is the fact that globally there has been a hesitancy among oil companies to significantly increase their drilling and production activity. Under the traditional playbook, when the price of oil is as high as it is today, $104 a barrel, production companies would be accelerating their spending plans to drill more wells and harvest more oil at the elevated price. However, after the 2014 collapse in crude prices, management teams seemed to have gotten the message from shareholders and become more disciplined with their capital spending and not aggressively drilled more wells when prices spiked. In addition, greater importance is being placed on environmentally sensitive and sustainable business practices, which has led to further constraints on drilling new wells. As a result, per the International Energy Agency, major U.S. energy companies are spending 30% less on drilling activities than in 2019. Moreover, the number of active wells within the United States has been more than cut in half from 9,000 to under 4,5000 since the start o the pandemic.
We believe constrained drilling activities is likely to sustain the present supply/demand imbalance in the market, leading to oil prices remaining elevated for some time. Sure, they could fall from current pricing that is above $100/barrel, but the economics would suggest prices going back to the $40-$50 range are less probable. Even if the economy were to soften, demand has historically (outside of the pandemic) only adjusted down a few million barrels a day during downturns. Given low levels of inventories, this would not be all that severe. Prices at the pump may still soften a bit, as refining margins are presently elevated given constrained inventories. However, sub $3 gas (or even sub $4) may not be in the cards for some time.
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