Can oil stay on the boil? Global insights with UBS Australia's Head of Energy Research Tom Allen

ASX small cap oil plays got back on the boil in March, so we asked an expert about the price outlook for the year ahead.

Prices for Brent crude oil (the global benchmark) will push towards $US70 a barrel through the middle of this year before averaging out at around $US65/b in 2021, UBS says.

Speaking with Stockhead, the bank’s Director of Energy & Utilities Research, Tom Allen, provided some nuanced insight on the macro factors underlining those forecasts.

Catalyst #1 – OPEC supply quotas

For junior oil & gas explorers, prices often rise and fall on the strengths of their exploration efforts.

A good recent example is 88 Energy (ASX:88E), which rose from 0.8 cents to over 7 cents in the space of a month before an equally sharp fall.

But aside from the risk and reward involved in new oil strikes, it helps to know what key catalysts are driving oil prices as the global economy emerges from COVID-19.

Allen said for starters, OPEC’s monthly meeting on production quotas is of acute importance in the context of post-COVID supply and demand.

The oil market is “quite fragile” at the moment, he said. On the supply side, “the monthly OPEC and non-OPEC Ministerial meetings are crucial for near term market stability”.

At the last meeting on April 1, the oil taps were (cautiously) released; OPEC member states agreed to a production pick-up of 350,000 barrels per day in May and June, increasing to 440kb/d in July.

An additional voluntary cut of 1Mb/d from Saudi Arabia — in place through February, March and April — will also be returned via a phased release.

“In May 250kb/d of production will return, followed by 350kb/d in June, with the final 400kb/d instalment of the 1Mb/d returning in July,” Allen said.

But even with that increase, “you’ve still got 5.8m bpd of curtailed oil supply from OPEC, which needs to be let back into the market”.

“It’s really important to the long-term stability of oil prices that OPEC quota barrels are returned to the market in an orderly fashion,” he said.

“So there is a bit of risk and volatility in the market when you’ve got OPEC meeting monthly to decide how to do that.”

Investors don’t need a long memory to recall the March 2020 skirmish between key OPEC states Saudi Arabia and Russia over COVID-related production cuts, which resulted in a historic price crash.

“This year we’ve seen good compliance from OPEC and OPEC+ members on sticking to those quota levels,” Allen said.

“But as we saw last year, when things unwind it can happen quickly.”

Super cycle?

While OPEC represents a crucial oil supply cog, Allen also summarised the central components on the demand side of the equation.

The COVID-19 recovery across major economies has been non-linear, and numerous indicators lend weight to the argument that economic activity is picking up steam.

However, unlike some other research houses, UBS doesn’t subscribe to the view that the pandemic has inadvertently kickstarted a new commodities super cycle.

“We do think demand growth in 2021 and 2022 will be above trend, but only because of the base effects from the collapse in 2020,” Allen said.

“We don’t think demand growth will be sustained like we saw in early 2000s, when you had the emergence of China as an enormous new demand centre.”

Still, ongoing discussions around further mass-scale fiscal support is an important near-term catalyst, Allen said.

“The real bullishness (for oil demand) is linked to the amount of fiscal stimulus that’s being unlocked in major economies around the world,” he said.

Initiatives like the Biden administration’s latest $US1.9 trillion stimulus package “helps put money into pockets of the middle class, who are typically fairly consumptive of commodities,” he added.

And that demand-side pull will act in concert with other post-COVID factors, which together support UBS’ forecast for Brent crude to push towards $US70/b through the middle of this year.

For starters, the pandemic prompted a material deferral in larger scale capex plans, while the normalisation of economic activity has resulted in a draw-down on oil inventories.

“The best we can judge is that the excess supply built up over first half of 2020 will have been reversed by the middle of this year,” Allen said.

Although as with other commodities, China is probably the “key factor” there.

“China took a lot of crude into storage in 2020, and it’s probably an open question about how much is for commercial use and how much is strategic and won’t actually come back,” he said.

“So that’s another risk factor, is how much of that storage China may release back into the market.”

Shale fail

Elsewhere, Allen said the view from the ground is that US shale oil producers also won’t be rushing back to flood the market with new supply.

“The incentive price for US companies to enter the market requires oil to hold around $US55-$US60 a barrel,” he said.

However, “we haven’t seen US supply force its way back into the market and regain market share at the levels some expected”.

Allen also cited the recent cold snap in the US oil heartland of Texas, which acted as an additional drag on supply.

“Speaking to CEOs of some of the companies that I cover, they’re quite open in their expectation that a good chunk of US supply won’t make it back into the market,” he said.

“(US supply) is very relevant in the context of global inventory levels. But nearer term the primary focus is on that stimulus-led demand story, and the supply quotas being managed through OPEC.”