Morgan Stanley says we need $100/bbl oil price

[dan_s]

Martijn Rats, CFA – Morgan Stanley
January 20, 2022 9:41 PM GMT

The oil price required to trigger sufficient demand erosion appears higher than we estimated. Hence, we raise our Brent forecast to $100/bbl by 3Q, up from ~$90/bbl before.

Heading for a 'triple deficit': As we wrote on January 6, we suspect that by the middle of the year, the oil market will likely see three critical factors simultaneously at low levels:
1) low inventories - these have fallen substantially in 2021 already, but on our estimates, will be lower still by end-2022,
2) low spare capacity - this has already come down from ~6.5 mb/d a year ago, to ~3.4 mb/d at the moment but will likely drop below 2 mb/d by mid-year, and
3) low investment, which is still close to the level of the IEA's 'Net Zero by 2050' scenario in which consumption and production are assumed to fall ~30% by 2030, whilst actual demand shows no such trend - also see our recent note on these topics The Oil Manual: Heading for a Triple Deficit.

Oil prices to converge to the demand-erosion level: When each of these three factors is 'tight', then demand growth needs to slow down so the physical flow of oil can balance. In our note Regime Change in the Oil Market: From Supply to Demand Destruction from June 2021, we argued that this requires oil prices to rise to the level where at least some demand erosion kicks in. However, this is likely higher than estimated before: Until now, we estimated that the demand-erosion price was ~$90/bbl, but this is likely too low. The key oil products markets (i.e. gasoline, jet fuel and gasoil/diesel) all show strong cracks spreads, steep backwardation, and inventories that have fallen to low levels. None of this signals weakness. Arguably cracks spreads have needed to rise to accommodate the higher cost of power, carbon credits and natural gas, but nevertheless, end-user demand has been strong enough to allow for both crude prices to rise and crack spreads to expand on top of that. Also, scheduled flights still point to a ~1.5 mb/d increase in jet fuel demand by the summer, and Google Mobility data is up sharply year on year.

So far, current prices do not seem to have held back the demand recovery. To reach the 2011-14 burden on GDP, Brent would need to rise to $100-110: If Brent were to stay at $88/bbl, spending on oil would amount to ~3.5% of global GDP this year. That is still modest in a historical context - it averaged ~4.5% consistently throughout 2011-14. To reach that percentage again, Brent would need to rally to ~$110/bbl, although sizeable regions of the world would already be at an oil-burden-on-GDP equal to the 2011-14 level if Brent were to reach $100/bbl. We suspect that Brent will need to rise to that latter level, which is our new forecast for 2H22 and 1H223.

We reiterate our long Dec 2022 trade recommendation first issued here. Also see: The Oil Manual: Heading for a Triple Deficit
The Oil Manual: Omicron Correction
The Oil Manual: Which Will Peak Earlier? Supply? Or Demand?
The Oil Manual: In Search of the Demand Destruction Price
The Oil Manual: Why OPEC Will Likely Balance the Market Again in 2022
The Oil Manual: Regime Shift in the Oil Market: From Supply to Demand Destruction
The Oil Manual: Oil, OPEC and ESG - Raising Long-Term Oil Price Forecasts
The Oil Manual: How Undersupplied is the Oil Market Really?