Barring an exogenous event, such as the development of a new COVID-19 variant, a pipeline hack, an armed conflict, etc, world oil markets will likely be characterized by low volatility and relatively stable prices for the rest of 2021. While world crude demand is rising on vaccination successes, crude supply appears adequate. With U.S. and world GDP growth potentially facing supply constraints, we see a near balance between downside than upside risks: WTI will generally trade within a $60 – 70/barrel range for the remainder of the year, although crude prices could spike in the next couple of months as part of a secular rise in inflation. We expect any surge in prices to be temporary, however, and expect macroeconomic growth to clock in at around 5%, less than what we previously hoped but still highly supportive of energy demand. If the U.S. can resolve some of its supply chain constraints within the next month or two, however, we will revise our expectations higher.
For over a year, we’ve consistently said that the macroeconomy is determining energy markets, and that the COVID-19 novel coronavirus drives the macroeconomy. That’s still true – but the situation is changing rapidly due to highly effective and safe vaccines. Within the next three months, barring a dangerous new variant, COVID cases will continue to fall in nearly every market and macroeconomic uncertainty will diminish. While there is some uncertainty regarding inflation (and whether the U.S. will face a one-off bout of inflation or something nastier and more persistent), “macro” factors are increasingly less important to energy markets. Microeconomic factors (which we’ll define as inventories, breakeven costs, transportation costs, etc) are always important, of course, but they will once again become ascendant if, as expected, the coronavirus begins to permanently recede later this year in nearly every market.
Crude demand and a disappointing April jobs report
The U.S. economy only added 266,000 jobs according to the latest jobs report, well below expectations of 1 million. The reasons for the shortfall are hotly debated and beyond the scope of this article. Needless to say, however, the disappointing jobs report makes 2021 U.S. annual GDP growth of 6%+ much less likely.
The jobs report ran counter to otherwise remarkably good news. U.S. and European COVID-19 cases are falling sharply on vaccines and favorable, outdoor-friendly weather; vaccine production is increasingly rapidly; Western and Indian vaccines have thus far proven effective against all variant strains; and the world is deploying nearly 24 million vaccine doses every day – a rate that will likely double or even triple by the end of the year. While another strain could emerge, the world appears to have reached the end of the beginning in the fight against COVID.
Supply constraints are weighing on the U.S. economic rebound. Many economists believe that labor supply has been constrained by COVID dynamics, overly generous unemployment benefits, and childcare/closed schools resulting in more burdens for parents; other economists disagree. Whatever the case, economists are in near-universal agreement that shortages of some commodities and supplies are constraining growth. Microchip shortages are causing automakers to shutter plants, while soaring softwood lumber costs are partially responsible for surging housing prices. Inflation risks seem manageable, for now, but that could change.
We believe, at least for now, that 2021 U.S. annual GDP growth will more likely come in close to 5%, down from expectations of 6%+ earlier this year. If the U.S. can accelerate its vaccination campaign and/or resolve its labor, softwood lumber, and microchip supply-chain issues, then growth could rebound sharply. Since energy demand is highly correlated with macroeconomic growth, we’re scaling back some of our optimism about 2021 crude exports and gasoline demand – although we still think it will be an excellent year for the U.S. oil and gas complex.
Crude supply: OPEC+
OPEC+ production is rising as the cartel struggles to maintain production quota compliance. According to S&P Platts, OPEC+ oil quota overproduction currently stands at about 3.3 Million Barrels per day (MMBPD). More international supply will likely come online in the next few months. Iran production has already reached 2.2 MMBPD, even though exports remain (for now) at around only 0.65 MMBPD. According to Argus Media, if sanctions are lifted, Iranian crude exports could reach 2.5 MMBPD, adding up to 1.8 MMBPD of medium and heavy crude grade supply to world markets. Similarly, Venezuela’s troubled oil industry may receive sanctions relief in the months ahead. Sanctions relief on Iranian + Venezuelan volumes could add approximately 1.5 – 2.0 MMBPD of crude supply in the coming months. Sanctions relief would have only an indirect impact on Permian and U.S. production, since U.S. crude grades tends to be lighter and sweeter than Iranian and Venezuelan production.
U.S. crude: a comeback – but constrained
United States crude production will likely grow this year, albeit not to the same degree witnessed in recent history. We expect crude production to grow to 11.3 – 11.5 MMBPD by 4Q2021, up from the ~11 MMBPD of production reported by the EIA in recent weeks. A few uncertainties will determine the trajectory of U.S. crude. The first, of course, is the U.S. economic recovery. If 2021 annual GDP growth reaches 6%+ then 4Q2021 crude production will almost certainly be closer to 12 MMBPD. Second, production from the Permian and other basins is becoming “gassier” as US producing wells age. According to S&P Global Analytics, current gas-to-oil ratios stand at 3 Mcf per barrel of oil, up from pre-pandemic levels of about 2.5 Mcf/b. “Gassier” production will limit crude oil production – particularly if producers turn to flaring. This brings us to our third uncertainty: how much will ESG constrain production? We think that ESG is here to stay: even in a best-case scenario, investors will be highly wary of returning to the sector unless ESG concerns are adequately addressed
Smoother, more certain
The gradual reduction of COVID in U.S. and world markets is likely to significantly reduce crude price volatility. The next month or two will tell us a lot: if the U.S. can resolve its supply chain constraints, accelerate vaccination uptake, and return to “normal,” crude production and prices could surprise on the upside. We’ll know more, soon.