Energy Prospectus

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BofA Equity Research: It won’t be a straight line, but is oil meandering to a supply crisis?
Industry Overview

$80 oil feels like nose bleed levels vs 2020

There are several reasons Brent breached $80, mainly the energy ‘crisis’ in Europe that
has seen benchmark gas prices spike above the equivalent of $200/bbl. Near term,
uncertain projections on likely fuel switching from natural gas to fuel oil has brought
forward the pace of the expected demand recovery but with no apparent rush from
OPEC+ at its 10/4 meeting to accelerate the current pace of its 400,000 bpd monthly
increase. But while spot prices have moved up, forward prices remain deeply backwardated
leaving a curious dynamic that is plentiful spare production capacity when
prices are highest and the ‘overhang’ that has kept oil prices depressed at the long end
of the curve. In our view, the simple explanation of this oil market is that OPEC+ (Saudi)
has regained control of the oil market – so that for at least the period necessary to
return spare OPEC capacity to pre-COVID levels, the trading range for oil prices can be
whatever Saudi determines it to be. But what about the post-COVID era? Remember
that per the IEA, spending in 2021 is running at ~half the levels of 2010-14, which
fueled much of the conventional and unconventional production growth between 2015-
19. In our view, the emerging question is whether the slowdown in spending has already
planted the seed for a tightening supply / demand balance over the post-COVID era.

… but n/term outlook says $20 backwardation rolls higher

Near term, heading into winter, a global power crunch has provided the catalyst to push
prompt prices to new highs as record high gas prices incentivize substitution. The read
through to oil demand is nuanced; but in a sustained switching scenario, our commodity
team projects that the oil deficit this winter could easily exceed 2mm bpd with top line
demand pushed up by 1-2mm bpd mainly from Asian fuel burning capacity, particularly in
Japan.

One of the principal concerns around the European gas situation is that Russian
exports cannot be relied on to solve the problem with the market trying to gauge
Russia’s capacity with heightened interest. Today as Dutch TTF forward prices hit
records, President Putin reiterated Russia as a stable partner to both Europe and Asia,
suggesting that Russia could in fact export record gas volumes to Europe this year. His
commentary sent TTF futures in a tailspin – but the reality may be less impactful: Mr.
Putin suggested that given a robust pace of exports for the first nine months of 2021,
maintained pace would imply record exports. In their recent report EEMEA Oil & Gas: Gas
prices spike, export fight looms (28 Sep 2021), our EEMEA oil team pointed out that
Gazprom’s production level is currently at a 10 year high – concluding that the reality is
that there may be limited opportunity for Russia to step in further. Meanwhile, oil
demand continues to move higher, notably as international travel is showing signs of
life. As OPEC+ remains cautious on supply additions, our commodity team continues to
see the ongoing backwardated oil curve ‘roll up’ higher, and directionally still expects to
see $100 Brent at some point in 2022.

Conclusion: For our part, we see this as merely the first leg of what we see
as potential for sustained recovery in both oil prices and oil equities anchored on
cyclical underinvestment and for a sector we continue to see on average
‘discounts’ average oil prices around $50 WTI

More details from BofA that are interesting. IMO OPEC+ does not have as much spare capacity as they are telling the market.

From BofA Report:

The buck stops with OPEC+, so where are the barrels?
The setup has effectively passed the buck to OPEC+ to play market management, but
relief from elevated near term prices may pend realization of the full extent of winter
weather and associated power shortfall.

To the surprise of many, at its meeting on Monday, OPEC+ nations agreed to continue a
cautious step up plan, adding just 400mbd in Nov as it has so far done for two
consecutive months but vs consensus that had expected double that number. On
balance, this keeps the group’s strategy intact, leaving dry powder ahead for what is still
an uncertain recovery into 2022, but to the detriment of major buyers – China, India and
even the US have all voiced concern on the current state of oil prices.

Notably, headlines from the latest Joint Technical Committee meeting suggest that
OPEC continues to forecast a supply surplus in 2022 which likely drives its near term
caution. But we’d be remiss in failing to mention that potential for a 2022 surplus looks
marginal at best with a risk skew that continues to point directionally positive on prices.
The latest Kayrros data shows that inventories are already normalized and before what
stands to be uncharacteristically strong winter demand from liquids demand in power
gen.

Further, as OPEC+ continues to build back capacity, it’s worth noting that current ‘spare
capacity’ implied by the cuts is thinner than it looks.
> Recall, Russia and Saudi’s baseline is 11mm bpd, a level that neither party has
maintained on a consistent basis in recent years.
> As of November, each country’s quota is set to increase to 9,913 mbod, the
implication being that of the 4.2mbod of spare capacity heading into an uncertain
winter, over half the implied level is held by Saudi and Russia.

If we were to optimistically assume 10.5mm bpd of sustained capacity for both names
(note – Russia is assumed net of 700mbd of condensate), actual spare capacity is
already 1mm bpd lower, effectively rolling forward OPEC+ step ups by 2.5 months.
Moreover, with Russia typically facing structural constraints around winter weather
output changes, the bottom line is that there are no guarantees that the remainder of
OPEC+ curtailments can infill the market as they currently imply.

And don’t be fooled by quota adjustments slated for April 2022. Of the ~1.6mmbod of
higher output implied by preliminary May 2022 quotas, 1mbod comes from even higher
adjustments to Russia/Saudi’s baseline which is moved up to 11.5 mbod. Iraq, UAE and
Kuwait make up the balance with Iraq in particular presenting geopolitical risk. The
historical production trend would suggest conservatively that less than half of this new
capacity can be sustained on any long term basis. In the most simple terms, while
there’s still ample spare capacity which holds the oil curve in a current >$22
backwardation, it’s not as much as OPEC+ curtailments would imply.

MY TAKE: By June, 2022 the global oil market will have NO SPARE CAPACITY and Q3 is the highest demand period of the year for transportation fuels. If I am correct this "Paradigm Shift" will push oil prices over $100/bbl and maybe much higher.

I see several economic forecasters saying $100 oil will break the world economy. I find that very hard to believe for several reasons. First we had nearly 4 years of oil around $100 from 2011 to 2014 and still world GDP grew. In today’s dollars, $100 in 2011 is $121 today. Second, in 2008 oil spiked to the equivalent of about $185 today. We are a long way from those prices. Perhaps in June 2022 things will look different, but with market liquidity at record highs, 2011 and 2008 may seem cheap.

I agree. Always remember that "Fear Mongering" is very good "Click Bait".