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Oil prices have rallied lately as investors are focused on the tight supply following news of production cuts by OPEC+.
Oil demand is also proving resilient, with IEA estimating global demand to grow by 2.2 million bpd in 2023, and by 1.0 million bpd in 2024. As we head into the fourth quarter, a supply deficit looks apparent and drawdown in inventories could leave the market exposed to even higher oil prices.
Over a longer-term basis, there is ample room for oil prices to remain at elevated levels, as structurally, the oil and gas sector is a market that is defined by underinvestment.
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.
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Oil prices have reached their highest levels in 2023 so far
Oil prices are up by nearly 30% in the third quarter after rallying since mid-June (Figure 1), with production cuts by the Organization of Petroleum Exporting Countries and its allies (OPEC+) contributing to this strong rally. Brent crude, a benchmark for prices, breached USD 95 a barrel in September, leading many to believe that USD 100 a barrel oil could be on the horizon.
Figure 1: Oil prices have been on a
rally
Supply curbs implemented by OPEC+ includes a combined 1.3 million barrels per day (bpd) voluntary cut from Saudi Arabia and Russia until the end of 2023, after both these countries had agreed to prolong their unilateral oil supply curbs by another three months in September. This move had exceeded market expectations for an extension of just one additional month.
Barring the low production levels during the Covid-19 pandemic, these cuts will see Saudi production slip to its lowest level since 2011. We do not expect OPEC+ to tweak its current oil output policy as tighter supplies and rising demand allows producers to rake in extra oil revenue despite pumping fewer barrels. For instance, according to Energy Aspects, oil revenues in Saudi Arabia are likely up by nearly USD 30 million a day compared with the April-June period, or an increase of about 5.7%.
Oil market to enter into a deficit in the fourth quarter
As a result of these production cuts, the market remains underpinned by ongoing supply concerns. In fact, the International Energy Agency (IEA) has warned that the extension of output cuts by Saudi Arabia and Russia through year end would likely result in a “substantial market deficit” through the fourth quarter.
Meanwhile, oil demand is also proving resilient, with IEA estimating 2023 global demand to grow by 2.2 million bpd to 101.8 million bpd, and by 1.0 million bpd to 102.8 million bpd in 2024. As available supplies lag behind this increase in oil demand, it could lead to a 2 million bpd a deficit in the fourth quarter. To cope with the tightening oil supplies, global inventories are being drawn down (Figure 2), and this drawdown in inventories could leave the market exposed to further price spikes.
Figure 2: Oil reserves are at historically low levels
Despite higher oil prices and falling inventories, the private sector response seems to have remained contained so far. For instance, looking at US domestic oil producers, the US oil rig count tracked by Baker Hughes has failed to rise in line with prices, and is even showing a decline lately (Figure 3).
Figure 3: US oil rig count has shown a decline lately in spite of the rise in oil prices
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. Instead, corporates prefer to focus on capital discipline, and adding to this lack of desire for investment is the on-going transition in energy markets to lower-carbon fuels. Thus, the many years of underinvestment in new production forms a strong fundamental backdrop for oil prices.
Higher oil prices flies in the face of efforts to tame inflation
The rise in oil prices has inspired fresh fears, as it flies in the face of efforts to tame inflation. Moreover, climbing oil prices increases energy costs for consumers and businesses, weighing on the global economy. 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.
Figure 4: US CPI components
We are currently in a unique situation, where despite economic uncertainties, oil prices have remained elevated, and may even move upwards 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 A2 USD. 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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