Oil market experiences significant fluctuations once again

The oil market has experienced significant fluctuations once again, with the benchmark West Texas Intermediate (WTI) crude surpassing the US$85 per barrel mark this week. This surge can be attributed to a combination of factors. Firstly, there is a more optimistic global economic outlook, which has boosted demand expectations for oil. Additionally, ongoing voluntary production cuts by OPEC+ have contributed to tightening supply in the market. Moreover, escalating tensions in the Middle East have added to concerns about potential supply disruptions. However, a critical factor influencing recent price movements is the Ukrainian drone attacks on Russian refineries, which have heightened geopolitical tensions and raised fears of further supply disruptions. This recent surge in oil prices contrasts sharply with the situation earlier in the year when WTI struggled to maintain levels above $70. During that time, there were concerns about OPEC+ cohesion, uncertainties surrounding the Chinese economy, and relatively low worries about supply disruptions stemming from conflicts such as the Russia-Ukraine tensions or the Israel-Hamas affair.

While crude oil prices remain uncertain, we think WTI will still find a happy medium around $80 per barrel. I think the outlook is relatively balanced for both upside and downside risks at this juncture, particularly considering that current oil price levels likely align with Saudi Arabia's preferences. This sweet spot is likely something OPEC+ wants to nurture rather than see higher prices create demand destruction.

One significant upside risk is the potential for disruptions in Russian and Middle Eastern production due to ongoing conflicts. While estimates vary, it is believed that Ukrainian drone attacks may have impacted up to 1.0 million barrels per day (mb/d) of Russian refinery capacity, with the potential for around 3.0 mb/d to be within striking range.

However, despite the improving global economic outlook, the likelihood of a substantial increase in global oil demand, exceeding 2.0 mb/d in 2024 compared to the current IEA projection of 1.3 mb/d, is relatively slim. It's worth noting that OPEC is officially forecasting a significant 2.3 mb/d increase in demand.

On the other hand, downside risks primarily stem from the possibility of the oil market becoming inundated with excess supply. At the same time, OPEC+ has demonstrated considerable cohesion since the fallout from the pandemic in early 2020; tensions within the cartel persist, leading to a significant portion of cuts being voluntary. It's evident that certain members, such as the UAE, are keen to increase production. Ultimately, the unity of the cartel hinges on Saudi Arabia's willingness to continue bearing the brunt of the cuts, currently accounting for 3.1 mb/d of the cartel's total reduction of 5.6 mb/d.

Riyadh's commitment to supporting the current production cut strategy of the cartel stems from its extensive, multi-year investment efforts aimed at diversifying its economy. However, it's reasonable to assume that the kingdom remains concerned about the potential loss of market share, especially to U.S. shale producers, and may eventually seek to scale back its cuts.

Additionally, there is a significant risk of non-OPEC+ production exceeding expectations, particularly due to the ability of U.S. shale producers to enhance drilling efficiency, primarily through the utilization of longer horizontal wells. The Energy Information Administration (EIA) conservatively forecasts a modest increase of only 300 kb/d in U.S. crude oil production this year (compared to +1.1 mb/d in 2023). Notably, the latest Dallas Fed Energy Survey indicates that U.S. producers can profitably drill a new well with an average WTI price of $64.