Nothing became clear last week; uncertainty persists and permeates the mood surrounding the global economy and markets. Events and data are being interpreted in a distinctly different manner. One day good news is good news, on the other it is bad. How should the market react after the IMF warned central banks not to get ahead of themselves in lowering borrowing costs or when inflation is expected to fall slower than last year due to tight labour markets and elevated service inflation in developed nations? The reaction was a rally in equities sending the S&P 500 index to a fresh all-time high. This optimism is in sharp contrast to the CME FedWatch Tool, which now puts the probability of the Fed lowering rates at 46% in March, down from 70% a week ago. What seems unambiguous is that peak rates have been reached, the timing of the first cut, nonetheless, is ostensible.

The same precariousness surrounds the oil market. Israel’s relentless obliteration of Gaza continues, so is the Houthi attacks on commercial vessels in the Red Sea and the US retaliatory measures. In an escalation, Iran has directly drawn itself into the conflict by seizing an oil tanker and striking military targets in Pakistan and Iraq. Yet, all that has happened was the understandable widening of Brent backwardation. Flat price yo-yoed and ended the week slightly higher but this strength, and WTI flipping back into backwardation was more of the function of a cold spell in the US than raised anxiety level of possible supply disruption from the Middle East. The sentiment is sourer this morning because the force majeure on Libya’s Sharara oil field has been lifted. Investors want to be bullish but tepid data and cautious narrative from policymakers keep them on the backfoot. It is increasingly perilous and even impossible to turn uncertainty into opportunity. The current snapshot, however, implies that global growth remains intact, oil demand will also increase therefore the risk is plausibly skewed to the upside, which, at least it seems from this chair, remains limited.

King’s Ransom

As outlined in Friday’s note both OPEC and the IEA expect global oil demand to rise this year, the former much more than the latter. The world, it appears, needs record amount of the black stuff but there is a yawning gap in absolute figures. To reiterate the numbers from the last report, OPEC expects consumption to reach 104.36 mbpd whilst the IEA foresees demand to climb to 102.98 mbpd. On a side note, breaking with tradition, OPEC published the first 2025 outlook 6 months earlier than usual and it sees another 1.85 mbpd rise on the demand side of the oil equation.

Given the broad agreement on non-OPEC supply (both sees it to climb to around 70.4 mbpd this year including Angola and OPEC expects an additional growth of 1.27 mbpd for 2025, well under the forecasted increase in global consumption) it is the diverging views on demand that are responsible for wild fluctuations in OECD stock estimates. The Feature Article of the IEA report characterizes 2024 as ‘reasonably well supplied’ which goes against the OPEC narrative. Predicting OECD inventories is a challenging task in itself: firstly, when it is derived from the changes in global stocks it is ambivalent what percentage occurs in the developed part of the world (we use 40%) and secondly, it is a Catch-22 to predict OPEC production figures going forward as high calls on OPEC’s oil should entail rising output from the alliance and vice versa. In our base case we assume an OPEC output level of 26.7 mbpd for 2024 and 27 mbpd for the following year.

What is obvious is that the high historic inverse relationship between OECD stockpiles and the price of Brent makes oil stocks in the rich part of the world an excellent tool to predict the cost of oil going forward. Taking into account seasonality and using OPEC figures one would find that in the last 15 years this correlation has stood at -89% in 1Q, -95% in 2Q, -90% in 3Q and -92% in 4Q.

The current quarter should see no considerable change from the comparable period of 2023. OECD oil inventories will edge somewhat higher therefore the formula shows an average Brent price of $81.63/bbl, some 50 cents/bbl under the 1Q 2023 average price. The notable changes start from 2Q onwards. According to OPEC and using 26.7 mbpd of production global oil inventories ought to decline by 1.72 mbpd in 2Q, 2.21 mbpd in 3Q and 2.03 mbpd in 4Q. These would lead to OECD inventories dropping to 2.712 billion bbls, 2.631 billion bbls and 2.556 billion bbls pushing the price of Brent to $89.55/$117.33/$103.05 respectively. Realistic? Time will tell but if the OPEC projections are replaced by the IEA forecasts quarterly Brent prices would drop to $78.62/$89.85/$90.67.

Employing the same method for 2025 the picture becomes even more extreme. As non-OPEC supply growth is dwarfed by the increase in global oil consumption the OPEC call will rise 460,000 bpd on average, from 28.49 mbpd in 2024 to 28.95 mbpd in 2025. An increase of 300.000 bpd in OPEC output will accelerate the annual stock draw from 1.79 mbpd this year to 1.95 mbpd next putting further and intense pressure on OECD oil inventories. Starting the year at 2.518 billion bbls they would decrease gradually throughout 2025 reaching 2.270 billion bbls by the end of the year pushing prices to as high as $174/bbl in 3Q of 2025.

Of course, the above calculation must be taken with a tablespoon of salt for several reasons: the 2025 prices are calculated from the 2024 levels so in case the latter proves overvalued the former must be adjusted accordingly. It is also noteworthy that in the implausible case of OPEC ‘s forecasts proving accurate the producer group will most probably increase its production (it has the capability to do so as the current spare capacity is around 5 mbpd). Lastly, high prices generated by perceived tight oil balance will likely be met with further increase in non-OPEC output, something that OPEC will not tolerate in the medium run. (The shrinking market share of the producer group will be discussed in detail in Wednesday’s report.) Allowing for some subjectivity and considering the current economic climate in the western part of the world as well as in China, OPEC’s demand estimates for the next two years and the resultant astronomical price forecasts seem perplexingly exaggerated.

tamas.varga@pvm.co.uk

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