BofA Oil Price Outlook - July 23
Posted: Fri Jul 23, 2021 11:08 am
From BofA Global Research: Raising the bar on OPEC spare capacity
22 July 2021
In our view oil volatility over the past week was as much about renewed COVID uncertainty, demonstrated by the 700 - 900 point gyration across the DOW on Monday, as about an OPEC deal announced concurrently, one day before the WTI contract expiry.
Since then markets have recovered and oil is again back above $70, having recovered much of its 1-day loss. So what ’ s going on? In our view the market has had a chance to absorb the implications of an OPEC+ deal that does three things: implies continued inventory draws in 2H21 assuming the expected demand recovery plays out, extends the cartel's intervention in oil markets through y/end ‘ 22 and the continued micro-managing of oil markets through monthly oil meetings, suggesting OPEC+ remains ready to adjust its plans to accommodate any unexpected shifts in the post-COVID recovery in either
direction. It also raises the bar on spare capacity for five of the OPEC+ participants, totaling 63mm bpd – capacity theoretically already funded and in our view, pushing out the timeline for any call on a resumption of meaningful growth from US E&P’ s.
Rolling up the curve
The combination is hardly a negative signal for oil markets: on the contrary we see OPEC+ strategy keeping markets tight at the front end but with ample spare capacity at the back end to sustain a price structure in backwardation not incentivizing storage, and as evidenced this week, maintaining enough support on oil markets for the forward curve to roll higher on expiry, as appears to have been the case this week. Should this continue, a backward look at average oil prices 12 months from now would be higher than the forward strip, which we view as the most likely basis for market e xp ec tat ions of value while keeping the gap between sector cash flows & valuations. It also begs one simple question for investors. Do you believe Brent will be ~$20 lower than is today, five years from now? Because that’ s what the future’ s curve says, and in our view leaves risks to what the market is currently discounting across the US oils being skewed h i g he r.
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Keep in mind that the NYMEX strip is not a forecast of where commodity prices will be in the future. Backwardation is bullish as the high front month contract prices tend to roll forward. NYMEX contracts are "derivatives". They are contracts to buy or sell oil at a fixed price adjusted for perceived risks over the time period between now and the contract expiration date. Also, backwardation discourages producers from putting oil in storage, which tightens the market.
22 July 2021
In our view oil volatility over the past week was as much about renewed COVID uncertainty, demonstrated by the 700 - 900 point gyration across the DOW on Monday, as about an OPEC deal announced concurrently, one day before the WTI contract expiry.
Since then markets have recovered and oil is again back above $70, having recovered much of its 1-day loss. So what ’ s going on? In our view the market has had a chance to absorb the implications of an OPEC+ deal that does three things: implies continued inventory draws in 2H21 assuming the expected demand recovery plays out, extends the cartel's intervention in oil markets through y/end ‘ 22 and the continued micro-managing of oil markets through monthly oil meetings, suggesting OPEC+ remains ready to adjust its plans to accommodate any unexpected shifts in the post-COVID recovery in either
direction. It also raises the bar on spare capacity for five of the OPEC+ participants, totaling 63mm bpd – capacity theoretically already funded and in our view, pushing out the timeline for any call on a resumption of meaningful growth from US E&P’ s.
Rolling up the curve
The combination is hardly a negative signal for oil markets: on the contrary we see OPEC+ strategy keeping markets tight at the front end but with ample spare capacity at the back end to sustain a price structure in backwardation not incentivizing storage, and as evidenced this week, maintaining enough support on oil markets for the forward curve to roll higher on expiry, as appears to have been the case this week. Should this continue, a backward look at average oil prices 12 months from now would be higher than the forward strip, which we view as the most likely basis for market e xp ec tat ions of value while keeping the gap between sector cash flows & valuations. It also begs one simple question for investors. Do you believe Brent will be ~$20 lower than is today, five years from now? Because that’ s what the future’ s curve says, and in our view leaves risks to what the market is currently discounting across the US oils being skewed h i g he r.
--------------------------------
Keep in mind that the NYMEX strip is not a forecast of where commodity prices will be in the future. Backwardation is bullish as the high front month contract prices tend to roll forward. NYMEX contracts are "derivatives". They are contracts to buy or sell oil at a fixed price adjusted for perceived risks over the time period between now and the contract expiration date. Also, backwardation discourages producers from putting oil in storage, which tightens the market.