Unexpectedly, oil and gas remain cheap

In the months following Russia’s invasion of Ukraine, any hint of bad news sent energy prices into the stratosphere. When a fire forced an American gas plant to close, when strikes clogged up French oil terminals, when Russia demanded that Europe pay for fuel in rubles or when the weather was worse than usual. usual, the markets went wild. Since January, however, things have been different (see chart). Brent, the global oil benchmark, hovered around $75 a barrel, down from $120 a year ago; in Europe, gas prices, at €35 ($38) per megawatt hour (mwh), are 88% below their August peak.

It’s not that the news has suddenly become more favorable. The Organization of Petroleum Exporting Countries (OPEC) and its allies have announced sweeping production cuts. In America, the number of oil and gas rigs has fallen for seven straight weeks as producers react to meager rewards on offer. Several Norwegian gas installations, now vital for Europe, are subject to prolonged maintenance. The Netherlands closes the largest gas field in Europe. Yet any price increases fade quickly. What is price maintenance?

A disappointing request may be part of the answer. In recent months, expectations for global economic growth have been scaled down. The failure of several banks this spring raised fears of an impending recession in America. Inflation hits consumers in Europe. In both places, the full impact of interest rate hikes is yet to be felt. Meanwhile, in China, the post-covid rebound is proving much weaker than expected. Anemic growth, in turn, is dampening demand for fuel.

Still, take a closer look and the claim story isn’t entirely convincing. Despite its disappointing recovery, China consumed 16 million barrels per day (b/d) of crude in April, a record. A rebound in trucking, tourism and travel from the grim zero-covid era means more diesel, gasoline and jet fuel are being used. In America, a 30% drop in gasoline prices compared to a year ago bodes well for the summer season. In Asia and Europe, high temperatures are expected to last, creating increased demand for gas-fired power generation for cooling.

A more compelling explanation can be found on the supply side of the equation. High prices over the past two years have encouraged production outside OPEC, which is now online. Oil gushes from the Atlantic basin, through a combination of conventional wells (in Brazil and Guyana) and shale and tar sands production (in America, Argentina and Canada). Norway also pumps more. JPMorgan Chase, a bank, estimates that non-OPEC production will increase by 2.2 MB/d in 2023.

In theory, this should be offset by the production cuts announced in April by major OPEC members (by 1.2 Mb/d) and Russia (by 500,000 b/d), to which Saudi Arabia has added 1 M bpd in June. Yet production in these countries has not fallen as much as promised, and other OPEC countries are increasing their exports. Those of Venezuela are on the rise, thanks to the investment of Chevron, an American giant. Iran is at its highest since 2018, when America imposed new sanctions. Indeed, a fifth of the world’s oil now comes from countries under Western embargoes, selling at a discount and thus helping to drive down prices.

For gas, the supply situation is more delicate: the main Russian gas pipeline delivering Europe remains closed. But Freeport Lng, a facility that handles a fifth of US liquefied natural gas exports and was damaged by an explosion last year, is back online. Other Russian exports to mainland Europe continue. Norwegian flows will fully resume in mid-July. More importantly, the existing stocks in Europe are vast. The block’s storage facilities are 73% full, up from 53% a year ago, and on track to hit their target of 90% before December. Rich Asian countries, such as Japan and South Korea, also have plenty of gas.

When inflation was soaring and interest rates remained low, commodities, especially crude oil, provided an attractive hedge against rising prices, pushing prices higher as investors flocked. Now that speculators expect lower inflation, the allure has faded, as has the appeal of safer assets like cash and bonds. As a result, net speculative positioning (the balance between long and short bets placed by punters in the oil futures markets) collapsed. Higher rates also increase the opportunity cost of holding crude inventory, so physical traders offload inventory. The volume of floating storage fell from 80 million barrels in January to 65 million barrels in April, its lowest level since the start of 2020.

Prices may well rise later in the year. The International Energy Agency, an official forecaster, forecasts global oil demand to hit a record 102.3 mb/d in 2023. Oil supply will also hit a record, but the forecaster estimates the market will swing into deficit in the second half of 2023, a view shared by many banks. As winter approaches, competition for LNG cargoes between Asia and Europe will intensify. Freight rates for the winter are already rising in anticipation.

Still, last year’s nightmare is unlikely to happen again. Many analysts expect Brent crude to stay near $80 a barrel and not hit triple digits. Gas futures markets in Asia and Europe point to a 30% rise from current levels by the fall, rather than something more extreme. Over the past 12 months, commodity markets have adjusted. It now takes more than a hint of bad news to send prices soaring.

© 2023 The Economist Newspaper Limited. All rights reserved.

From The Economist, published under licence. Original content can be found at https://www.economist.com/finance-and-economics/2023/06/19/against-expectations-oil-and-gas-remain-cheap

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