Brent crude oil prices have jumped above $90 per barrel, driven by heightened geopolitical tensions that threaten to disrupt global oil supplies, and this could rise further in coming months due to geopolitical developments, said a new report.
This comes as the oil market was already heading into a large deficit in the fourth quarter due to output cuts by OPEC and its allies.
According to the report, the outlook remains robust for crude prices to stay elevated on tight supply-demand balances. However, some moderation in demand growth is expected from 2024.
“Brent crude price has jumped to +USD 90/bbl driven by potential supply side risk if Middle East conflict widens to other countries,” said Dayanand Mittal, author of the report and oil analyst at JM Financial.
The International Energy Agency (IEA) estimates global oil demand will grow by a strong 2.3 million barrels per day (bpd) in 2023 to 101.9 million bpd, before moderating to growth of 0.9 million bpd in 2024.
Meanwhile, supplies remain constrained by the OPEC+ alliance led by Saudi Arabia and Russia. Their deal to voluntarily cut output by 1.3 million bpd, on top of previous curbs, will keep the market in a large deficit in Q4 2023.
“This supply side risk comes at a time when oil market is already expected to be in substantial deficit in 4QCY23 due to 1.3mmbpd voluntary oil output cut by Saudi Arabia and Russia till end-Dec’23,” Mittal explained.
OPEC+ Cuts Offset US Supply Growth
In September, OPEC+ crude production was 1.7 million bpd below year-ago levels. Output fell led by 2 million bpd cuts by Saudi Arabia and 0.3 million bpd by Russia.
This offset gains from the United States, Brazil and Iran. US crude output has stagnated below pre-pandemic highs as shale companies exercise capital discipline.
“OPEC+ supply in Sep’23 was at 43.1mmbpd vs. 44.8mmbpd in Sep’22 driven by output cuts by Saudi (2.0mmbpd) Russia (0.3mmbpd); partly offset by higher output from Iran (0.6mmbpd), Nigeria (0.4mmbpd) and Kazakhstan (0.4mmbpd),” said Mittal.
Inventories Shrinking Fast
Globally, commercial oil inventories fell a substantial 64 million barrels in August 2023 to a 13-month low. OECD commercial inventories were still around 105 million barrels below 5-year average levels. Falling stocks indicate the market is undersupplied.
According to the IEA’s latest Oil Market Report, the global oil market will remain in a large deficit of around 1.5 million bpd in Q4 2023.
“This supply side risk comes at a time when oil market is already expected to be in substantial deficit in 4QCY23 due to 1.3mmbpd voluntary oil output cut by Saudi Arabia and Russia till end-Dec’23,” explained Mittal.
The supply curbs and inventory draws have firmed up crude prices. Brent jumped above $90 per barrel in October on fears of potential disruptions. Tensions spiked amid Iran’s nuclear program and conflict involving Israel.
“Brent crude price has jumped to +USD 90/bbl driven by potential supply side risk if Middle East conflict widens to other countries,” said Mittal.
Saudi Fiscal Breakeven Supports $80 Oil
According to JM Financial, OPEC+ will likely aim to keep prices around $80 per barrel. That is the fiscal breakeven level for Saudi Arabia to balance its budget.
“We still believe OPEC+ will continue to use its strong pricing power to support Brent crude price ~USD 80/bbl, which is the fiscal break-even crude price needed by Saudi Arabia,” explained Mittal.
With shale capital discipline, OPEC+ has enough spare capacity to cut output further if needed. This gives it substantial control over prices.
“The pricing power of OPEC+ has got strengthened over the past 2-3 years due to: a) US oil production continuing to be at ~13mmbpd only vs. pre-Covid peak of ~13.1mmbpd; and b) OPEC+ having shown strong ability to cut output by ~10mmbpd in early CY20 to offset the ~10% decline in global oil demand post Covid,” said Mittal.
Long-term Demand Growth Moderating
While market deficits support prices over the next 6-12 months, oil demand growth is expected to moderate post-2023.
The IEA trimmed its 2024 oil demand growth estimate by 0.1 million bpd to just 0.9 million bpd. Slower GDP growth, penetration of electric vehicles, efficiency gains and high prices will curb consumption.
“However, demand concerns continue as IEA cuts global oil demand growth estimate for CY24 to 0.9mmbpd; though CY23 global growth estimate marginally raised to 2.3mmbpd,” noted Mittal.
Upside Risks Remain
Geopolitical tensions, especially in the Middle East, pose upside risks to the crude price outlook.
“Flaring of geopolitical risk could amplify oil market deficit,” said Mittal.
Tighter sanctions on Iran, conflict involving Saudi Arabia, and supply infra risks could rattle markets. In 1973, an oil embargo by Arab nations in response to Western support for Israel sent prices skyrocketing.
While not the base case, such risks remain under the surface. OPEC+ spare capacity provides some cushion, but a major supply disruption could send Brent well above $100 per barrel.
“This supply side risk comes at a time when oil market is already expected to be in substantial deficit in 4QCY23 due to 1.3mmbpd voluntary oil output cut by Saudi Arabia and Russia till end-Dec’23,” said Mittal.
Indian Oil Companies to Benefit
For Indian oil firms, the higher crude price outlook is positive for earnings and cash flows.
Mittal remains bullish on Oil and Natural Gas Corporation (ONGC) and Oil India Limited (OIL), setting price targets of Rs 220 and Rs 345 respectively.
He explained: “We maintain BUY on ONGC (TP INR 220) and Oil India (TP INR 345) given strong 6-8% dividend play and also because CMP is discounting ~USD 55-60/bbl net crude realisation, while our TP is based on USD 65/bbl net crude realisation.”
The higher prices will boost revenues for integrated firms like ONGC and OIL. By contrast, high crude poses margin risks for downstream refining and marketing companies like IOCL, HPCL and BPCL.
“However, we maintain our near-term cautious view on all OMCs given their marketing segment earnings could come under risk if Brent price sustains above USD 90/bbl,” remarked Mittal.
At current elevated prices, auto fuel marketing margins for oil marketing companies have dipped below historical averages. But if Brent moderates around $80/bbl as expected, margin outlook would improve.
In summary, crude prices are supported by persistent OPEC+ supply curbs and declining inventories. The demand growth outlook is positive near-term but moderating longer-term. With geopolitics a wild card, risks remain tilted to the upside for oil over the next 12-18 months.