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Saudi Arabia, the world's top oil exporter, extended its 1 million barrel per day production cut to the end of September, and warned that more could follow. Russia has also added to the supply tightness with an announcement that it will cut oil exports by 300,000 bpd in September.
Oil demand is also proving resilient, with the IEA forecasting a pickup in demand even amidst recessionary fears. There is little supply response in sight, and US inventories are running at historically low levels. This forms a strong fundamental backdrop for oil prices.
The rise in oil prices flies in the face of efforts to tame inflation by the Fed. There is a possibility that we might see inflation spike higher in future, as soon as the high-base effects of energy prices witnessed in 2022 starts to moderate, or wear-off.
Investors may wish to consider the Blackrock World Energy Fund, if they are seeking a dedicated energy fund. Alternatively, investors can also consider the Blackrock Natural Resources Growth & Income Fund to get a diversified exposure to the commodities sector comprising of energy, mining, and agriculture.
What is happening to oil prices?
Crude prices have risen to a three month high (Figure 1), with the West Texas Intermediate (WTI) Crude trading above USD 84 on 9 August 2023, on the back of renewed production cuts that are expected to tighten global oil supplies.
Figure 1: Oil prices rose to a nine-month
high 
The recent run-up comes after Saudi Arabia and Russia have cut production to curb supplies in the market. Earlier in June this year, Saudi Arabia, the world’s top exporter said it would slash oil production by 1 million barrels a day starting in July. This was initially extended into August, but is now extending to another month to include September.
Barring the low production levels during the Covid-19 pandemic, these cuts will see Saudi production slip to its lowest level since 2011. Moreover, Saudi Arabia has warned that it could extend the cut beyond September, or make a deeper cut to production in future. Meanwhile, Russia has also said it would cut oil exports by 300,000 bpd in September. As such, the OPEC+ group is cutting production in a bid to tighten the market and shore up oil prices.
News of supply cuts, coupled with an improving outlook for the US economy has helped propel the oil price rally. The GDP in the US grew 2.4% on an annualised rate last quarter (2Q23), according to preliminary figures released by the Department of Commerce, topping the estimates of 2%. This has led to growing investor optimism about a soft landing, and has helped propel the oil price rally.
Moreover, heightened tensions between Kyiv and Moscow after a Ukrainian drone attacked a Russian-flagged oil tanker on 5 August 2023 over in the Black Sea, a key waterway for the nation’s exports also contributed to the rise in oil prices.
Related article: The era of cheap oil has come to an end. Don’t expect a recession to change this.Tighter balance for oil in the second half of the year
As a result of these production cuts, the market remains underpinned by ongoing supply concerns. At the same time, oil demand is also proving resilient, with the International Energy Agency (IEA) forecasting a pickup in demand.
According to the IEA, oil demand is expected to grow by 2.2 million barrels a day this year to 102.1 million barrels a day and expand by a further 1.1 million bpd in 2024. The IEA expects available supplies to lag behind this increase in oil demand, leading to a 2 million bpd a deficit (Figure 2).
Figure 2: Global oil market has been expected to run short of supply
As demand outpaces supply, US inventories have also begun to fall. Currently, US inventories are running at historically low levels, and it was reported on 2 August 2023 that stocks fell by 17 million barrels in the week, the largest drop since 1982 according to the Energy Information Administration (Figure 3).
Figure 3: Oil reserves are at historically low levels
Lastly, the latest data from Baker Hughes shows that the US oil rig count declined by an eighth consecutive week to 525 on 4 August 2023, reaching the lowest level since March 2022. This is in spite of the recent strength in oil prices, suggesting that oil exploration companies are exercising caution and assessing the stability of the current market strength.
This is unsurprising, as structurally, the oil and gas sector is a market that is defined by underinvestment. This is a persistent problem that is difficult to change, with investment being on a downward trend since peaking in 2014. Thus, beyond the short-term, years of underinvestment in new production forms a strong fundamental backdrop for oil prices.
Related article: Commodities are down but not out. Here’s why the bull market is far from over.
Implications of higher oil prices in the fight against inflation
Inflation inched up in July, with the US consumer price index (CPI) rising 3.2% year-over-year (yoy), up from June’s 3.0% pace, and breaking the streak of cooling figures. Inflation has fallen from its peak of 9.1% in June 2022, and notably, the fall in energy prices given the high base effects yoy has contributed to this (Figure 4).
Figure 4: US CPI data has showed a decline in inflation brought by
energy prices
However, the rise in oil prices flies in the face of efforts to tame inflation by the Fed. Not to mention, there is a possibility that we might see inflation spike higher in future, as soon as the high-base effects of energy prices witnessed in 2022 starts to moderate, or wear-off.
Where it stands, we are currently in a unique situation. Although a recession is still likely on the cards, it does not automatically mean that oil prices would go down, given the relentless drive of OPEC+ to keep oil prices higher by pre-emptive supply cuts. Over the longer-term, constraints on production coming from years of under-investment would likely mean that oil prices will likely remain higher for longer.
With this in mind, investors may wish to consider the Blackrock World Energy Fund. The fund has exposure to integrated players with an emphasis on production, which are well-poised to benefit from higher for longer oil price environment. Alternatively, investors can also consider the Blackrock Natural Resources Growth & Income Fund to get a diversified exposure to the commodities sector. The fund invests in natural resource companies, such as those involved in oil and gas exploration and production, as well as in metals and mining.
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