The emergence of the Omicron variant in late November ended the year-long oil price rally, but analysts are still trying to gauge the full impact. A fresh set of reports from analysts see weakening demand as case counts surge, although there is little consensus on the magnitude of the hit.
Nevertheless, the oil market is on track for a supply surplus in early 2022, and some experts see OPEC+ pausing the production increases in response.
The International Energy Agency (IEA), the U.S. Energy Information Administration (EIA), and OPEC released their monthly oil market reports in mid-December. The IEA cut its fourth quarter oil demand forecast by 300,000 barrels per day, and the first quarter of 2022 by 630,000 barrels per day. Those numbers look less dramatic when averaged out over the full year – a cut of just 100,000 barrels per day for both 2021 and 2022.
The IEA noted that this would be a welcome development given the run up in prices over the past few months. “As 2021 draws to a close, the oil market appears to stand on a better footing than it has for some time. Much needed relief for tight markets is on the way, with world oil supply set to overtake demand starting this month,” the agency said.
“As 2021 draws to a close, the oil market appears to stand on a better footing than it has for some time.”
The IEA also somewhat waved away dire fears about the Omicron variant, arguing that “initial pessimism has now given way to a more measured response.” The new variant will “temporarily slow, but not upend, the recovery in oil demand that is underway,” the IEA said, with demand rising to pre-pandemic levels at around 99.5 million barrels per day next year.
OPEC was even less concerned, leaving its previous forecast unchanged, stating that Omicron’s impact would be “mild and short-lived.” That, of course, remains to be seen, and with cases and positivity rates soaring, such nonchalance seems misguided.
While the demand picture remains highly uncertain, the other side of the ledger offers a more bearish tinge to the outlook. Surging oil supply from both OPEC+ and a few non-OPEC countries, including the U.S., pushes the market into surplus territory in 2022, most analysts now agree. The IEA sees oil inventories rising at a rate of 1.7 million barrels per day (Mb/d) in the first quarter, and by 2 Mb/d in the second quarter, absent a policy change from OPEC+.
While the demand picture remains highly uncertain, the other side of the ledger offers a more bearish tinge to the outlook.
Central bank policy is another wild card, and the U.S. Federal Reserve signaled in recent days that it would begin unwinding some pandemic-related monetary stimulus. Typically, such tightening provokes a negative reaction in financial markets, but the opposite occurred mid-week. Analysts suggested that investors like certainty, and hope that the Fed’s new direction would tackle inflation.
“The fact that the financial market environment is generally somewhat less risk-averse lent buoyancy on the one hand: with its accelerated exit from its ultra-expansionary monetary policy, the Fed is apparently giving the impression that everything is under control,” Commerzbank said in a note to clients on December 16.
But the bank’s analysts urged caution. “All the same, we are sceptical despite the latest news that the good sentiment on the oil market will be carried over into the first quarter. After all, a substantial supply surplus is looming, especially if strategic reserves are actually released, as has been announced.” The bank added that potential travel restrictions in China remains a risk to the demand outlook.
OPEC+’s next move
Rising supply and the potential for weakening demand (or a softer-than-expected increase) will likely keep oil prices from returning to the mid-$80s per barrel last seen in November. And a more intense fifth wave from Omicron could spoil the outlook even further.
In a sign that the market is weakening, the timespreads for prompt oil contracts flipped into a contango structure – a jargony term that refers to oil for immediately delivery selling at a cheaper price than futures at a later date. The interpretation is that the oil market is well-supplied in the short run.
A weaker market, in turn, could push OPEC+ to pull an about-face on its planned production increases, scheduled at 400,000 barrels per day with each passing month. The market expected OPEC+ to delay the production increase for December, but OPEC+ surprised oil watchers by going ahead with the increase. Now, with production increases elsewhere and the new variant threatening to deepen the public health crisis, analysts see even more reason to hold off on pumping more oil.
A weaker market, in turn, could push OPEC+ to pull an about-face on its planned production increases, scheduled at 400,000 barrels per day with each passing month.
Investment bank Standard Chartered lowered its demand outlook earlier this month, noting that Omicron leaves OPEC+ with “limited immediate scope for output increases.” The bank places odds on OPEC+ hitting the pause button on production increases at 60 percent at the group’s upcoming meeting in early January, with a 40 percent chance that the cartel rolls back the December increase.
In short, “there will be a surplus every month in H1-2022, and demand risks are still weighted towards the downside,” the analysts concluded.