As so many times in the recent past US oil investors took a distinctively different view from Europe yesterday. A morning rally of more than $2/bbl was followed by a sharp sell-off of an even greater extent with the refreshing exception of Heating Oil and Gasoil. Whether this reversal of fortune was the product of fundamentally diverging views or was triggered by the US data tsunami will remain a mystery. The fact of the matter, however, is that after the release of the US private payrolls, the manufacturing PMI, the weekly oil stock report and the Fed interest rate decisions there was a growing belief that one more rate hike remains plausible, and the sellers became dominant.

Which is perplexing. The US private sector added less jobs in October than anticipated but the labour market is still considered tight. The index that measures US manufacturing activity showed a contraction for last month. It is attributed to the auto workers strike, which has been resolved. In other words, the world’s biggest economy remains resilient. That much was acknowledged by the Fed as they left benchmark rates untouched. And a strong economy entails further rate hikes, right? Well, not axiomatically as headline inflation fell from 9.1% in June last year to 3.7% in September with the core reading down from 6.6% to 4.1% in a year. There is still some way to go to achieve the 2% target, nonetheless monetary tightening has been working effectively and additional rate increase would probably do more harm than good.

This view was somewhat validated by the performance of equites and bonds as the former strengthened and the yields on bonds plummeted. So, why did oil continue to decline? Tensions in the Middel East, despite the partial re-opening of the Rafah border crossing linking Gaza and Egypt, have not eased and a region-wide escalation is more than just a distant possibility. The US stock report was more or less a non-event, but a few developments caught the eye. Crude oil stocks, nationwide and Cushing, are historically depleted, yet the front WTI spread is getting ever closer to contango. Commercial oil inventories started to dwindle, a harbinger of things to come on the northern hemisphere this winter. It looks as though that there is no evident fundamental justification for protracted weakness, therefore the present sell-off could be speculative in nature. And if it is the case one can only, well, speculate, when money managers find the current retreat a more than tempting opportunity to get back on the gravy train.
 

Irreconcilable Differences

The double blow of Russia’s invasion of Ukraine and the transition from fossil fuel to renewable energy has thrown forecasting the oil balance into disarray. The war Russia wages against its neighbour forced major players on the geopolitical front to take sides. It can generally be concluded that this almost coerced choice has pitted oil producers against consuming nations. Even before the invasion Russia became part of the group that consists of the most significant oil exporters and after February 2022 the fault lines became ever so conspicuous. (The notable exception is the world’s second biggest oil consumer, China, which is walking the fine line of explicitly supporting Russia by employing a transactional attitude whilst is fighting its own political, ideological and economic war against the West in general and the US in particular.) These differences between consumers and producers are much starker in the fight against climate change. To simplify the lack of consensus, producers see protracted reliance on fossil fuel, but consumers expect global oil demand to peak in the very foreseeable future.

The incoherent approaches spread beyond verbal spats and are embodied in the yawning gap of how oil producers and consumers assess the global oil balance for decades to come.  OPEC made its view crystal clear when it published its latest World oil Outlook that covers the period throughout 2045. The organization was at pains to point out that albeit the transition is irrevocably under way it must not happen at the expense of energy security and calls for a sustainable path that ensures economic growth whilst at the same time reduces carbon emission. It envisages an unavoidable investment of $14 trillion in the oil sector over the next 22 years and expects global oil demand to grow to 116 mbpd under the Reference Case scenario. Supply from non-OPEC producers will not match the growth in consumption, consequently the call on OPEC will advance leaving the cartel the swing producer of the oil world.

Conversely, the IEA expects demand for fossil fuels, oil, natural gas and coal, to reach its zenith by 2030. After this period there will be a significant decline in coal use whilst the consumption of oil and gas will plateau rather than plunge. In the Executive Summary the agency points to the emergence of a new clean energy economy, namely in solar and electric vehicles, as the main reason for its peak oil and gas demand estimates. It underlines the 40% increase in investment in clean energy since 2020. One in 5 cars sold in 2023 is now electric compared to one in 25 three years ago. The addition of renewable generation capacity will amount to more than 500 gigawatts in 2023 and over $1 billion is spent on solar deployment a day this year. Clearly, the IEA is much more optimistic of a hastened transition than OPEC and it is neatly on display in its projection of global oil demand in the next two-three decades.

Its view of fossil fuel consumption peaking by 2030 is based on several developments. It notes that the share of fossil fuel in the energy supply is expected to edge towards 73%, down from the recent level of 80%. There are indications that demand for fossil fuels will abate. The sales of cars and two/three-wheel vehicles with internal combustion engines are below levels registered before the outbreak of the Covid-19 crisis. The number of new natural gas and coal-fired power plants are falling. Sales of residential gas boilers are now below the sales of heat pumps in the US and Europe.

True to its view, the IEA’s prediction of futures oil demand is in sharp contrast with that of OPEC. The IEA, under its Stated Policy Scenario, expects oil demand to be 101.5 mbpd by 2030 and shrink to 97.4 mbpd by 2050. It is worth pointing out that Chinese demand is set to grow to 16.4 mbpd in 7 years’ time only to retreat to 12 mbpd by 20 years later. Whilst OPEC broadly matches the 2030 figure with its own estimate of 102 mbpd, by 2045 it expects global oil consumption to grow to 116 mbpd. The same is true for China. The country will demand 16.7 mbpd of oil in 2030, which will then relentlessly grow to 17.4 mbpd by 2045, 45% above the IEA’s 2050 call.

These diverging views then permeate down to investment levels. As reiterated above, OPEC thinks an investment of $14 trillion is needed throughout 2045 in the oil sector. To which the IEA counters that investment level needed by 2030 is the equivalent of the 2023 level and calls for higher investment are not based on the latest technology and market trends.

Medium-term forecasts, even if they turn out to be inaccurate, have always carried significance in future investment decisions. The deviating outlooks on the reliance on fossil fuel for the next 20-30 years will make these decisions more complex than before. It will inevitably lead to continued volatility in the energy markets. The differing projections will guarantee prolonged disagreements about the most effective way to manage the transition period. The next clash, without an obvious winner, will take place in the UAE during the COP28 climate change conference at the end of the month. Heated exchanges of views will ensure that the temperature in the conference room will rise faster than the target of 1.5 C set out in the Paris Agreement.

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