Morgan Stanley: $90 Brent forecast for Q3 - Jan 6

[dan_s]

Martijn Rats, CFA – Morgan Stanley Equity Research
January 6, 2022 4:08 PM GMT

On current trends, the oil market could see simultaneously low inventories, low spare capacity and low investment levels by 2H 2022.

There are risks around our forecast, but with this prospect, we reiterate our $90/bbl Brent forecast for 3Q.

Risks to oil price remains skewed to upside: Oil prices rose ~50% last year, making 2021 one of the strongest years in the oil market in recent history. However, we suspect that further strength lies ahead. Our balances look softer in 1H, but the oil market could see a triple-deficit by 2H:
#1 Investment - Under pressure in 2021….: Of all categories of spending, exploration remains particularly hard-hit. In 2021, the number of exploration wells completed dropped another 27%, and global discoveries fell to a 20+ year low. Field development fared better, but only marginally. Oil companies approved new investments for just 12.6 bn barrel of future production - outside 2020, also 15+ year low. Development capex increased ~5% in nominal terms, but taking into account cost inflation - now running +11% y/y - capex in real terms per unit of oil & gas consumed fell another 5% last year to a new 15+ year low....and unlikely to rebound in real terms in 2022: In nominal terms, development capex is likely to increase ~8-9% in 2022, based on company guidance and estimates from consultants. However, if even inflation were to slow sharply from here, costs are still likely to be ~5% higher in 2022 on average. With combined oil & gas demand likely to increase by 3-4% as well, we estimate, real-term capex per unit of consumption is likely to stay broadly flat at the 2021 level, which is ~20% below the 2006-08 level, before the industry's capex boom of the early 2010s.
#2 Spare capacity - Likely to fall below 2 mb/d by 2H: OPEC+ spare capacity has already fallen from ~6.6 mb/d at the start of 2021, to ~3.4 mb/d by November. From here, we expect OPEC+ (excl. Iran) production to increase by ~250 kb/d per month in 1H and largely flatline in 2H. That is far slower than the 400 kb/d monthly quota increase that OPEC+ has agreed on, but still would lead spare capacity to drop below 2 mb/d in 2H, leaving a relatively small buffer.
#3 Inventories Low already; draws to resume by 2H: On our analysis, observable inventories fell by ~690 mln bbl in 2021, a rate of decline of ~1.9 mb/d, and are now at a 5+ year low. However, with a constructive demand forecast and relatively cautious expectations for OPEC+ supply, we expect inventories to end 2022 lower still.

We reiterate our forecast for $90/bbl by 3Q: With the prospect of low inventories and spare capacity by 2H, further demand recovery into 2023, and still limited investments being made, the oil market appears to be heading for a period with little margin of safety. As a result, we expect that prices will need to rise to levels where some demand erosion takes place. We estimate that level at ~$85-90/bbl and expect Brent to test the upper end of that range in 3Q.