Oil prices have plunged over the past 12 months and remain volatile. interactive investor’s head of equity strategy Lee Wild asks Panmure Gordon’s oil & gas analyst Ashley Kelty what’s going on and what he thinks will happen next.
Lee Wild, head of equity strategy at interactive investor: Hello. With me today I have Ashley Kelty, director and oil & gas research analyst at Panmure Gordon. Hi Ashley.
Ashley Kelty, director and oil & gas research analyst at Panmure Gordon: Hi, how are you?
Lee Wild: Very well. Look, just a bit of background to begin with. The price of oil fell from over $120 a barrel in June last year to around $65 in March this year. Could you please explain to viewers what was behind both the surge and subsequent slump in price?
Ashley Kelty: Well, the surge last year was primarily on the back of the conflict in Ukraine. Prices had been rising at the start of the year due to general shortages of supply and OPEC failing to meet quotas.
However, this removal of Russia from the markets through sanctions, which Russia is essentially the world’s second-biggest producer, was going to cause huge shockwaves. I think a lot of people didn’t understand what the impact would be in terms of removing that and the impact on physical supply in the short term.
So there were a lot of moves to try and buy oil forward and that pushed the price up. However, it did seem to get watered down in the second half of the year when people realised the impact, or lack of, in terms of sanctions.
I mean an example would be that Boris Johnson was given a lot of stick for insisting that diesel was phased out over the course of 2022. However, what they didn’t understand was that around 35% of all the UK’s diesel came from Russia.
So obviously they couldn’t have phased that out overnight. If they had the impact on logistics, freight, rural communities and the general public would have been absolutely devastating, and I don’t think people would have been very happy to have a huge spike in prices that was for diesel just to feel happier that they were punishing Russia for Ukraine. So obviously the UK had to find alternative sources and that took time over the course of the year.
I think it’s also important to remember that there’s the prevarication of the G7 and the EU about the imposition of sanctions, a price cap on Russian oil, and this allowed Russia time to divert supplies and for other people to source alternate means of securing fuel.
I think another factor that also caused the price rise was the fear of recession and the impact on China of their zero-Covid policy, which exacerbated the risk of recession, so prices fall down, particularly since China is the world’s biggest importer of fuel and obviously will be a big driver to the global economy.
I think the fears about a global recession in the second half of last year did trigger a bit of a sell-off in commodities as there wasn’t the expected rise in demand. There was physical over-supply from the US strategic reserve as President Joe Biden moved ahead in the mid-terms to try and get prices at the pump down in the hope of winning over voters. And that was 180 million barrels that the market had not expected. It created a perception that there was more over-supply in the market which pressed prices heading into this year.
But the key was China taking time to reopen. The abandonment of its zero-Covid policy at the end of last year has certainly pushed prices up this year as demand is growing. I think we saw that with GDP numbers for the first quarter, it was at 4.5%, which was much higher than people were forecasting, and that’s an encouraging sign. The rebound hasn’t been as great as people have expected, it’s been a bit choppy I think to be honest, but it is reopening and certainly the IEA expects that China will account for most of the demand growth this year.
There are also other factors which are impacting physical supply at the moment. There is the closure of the Iraq/Turkey export pipeline following a dispute over Kurdistan and that removes about 450,000 barrels a day.
And there is also the impact of Russia reducing its output. While it said that its target is a reduction of 500,000 barrels a day, it hasn’t managed to get there yet, but the markets are largely driven by sentiment at the moment. And I think we can see why prices have bounced back this year, certainly as there is a physical supply squeeze in the first few months of this year.
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Lee Wild: Well, we were below $65. At one point, you know, just a month ago, around a month ago, now we’re above $80 a barrel.
Ashley Kelty: Well an element of the sharp bounce back has been the cut, surprise cut, by OPEC at the end of March where they’ve reduced it by 1.2 million barrels a day. And that, coupled with the previously announced cuts, will remove over 2% of global supply. Now this has certainly driven supply down and obviously demand is rising.
With China beginning to reopen, there is obviously a snapback for that and there is some near-term physical squeeze, particularly exacerbated by, as I mentioned earlier, Russian supply being cut and also the impact of the Iraq/Turkey export line
However, the sell-off in the early part of the year was largely sentiment driven. It wasn’t driven by fundamentals, they have remained strong throughout. The pace of demand growth has changed, it’s been a bit slower than people expected, but everyone agrees that there will be demand growth.
The sentiment was triggered by the collapse of Credit Suisse and Silicon Valley Bank and that spooked wider markets which then triggered risk-off sentiment amongst investors which pulls capital away from commodities. However, now that we don’t appear to have a full-scale banking crisis, people have become more bullish about the markets and that has brought them back into commodities.
Fundamentals are still strong, as I said, and I think that prices should rise heading into the second half of this year.
Lee Wild: Great. Ashley Kelty, director and oil & gas research analyst at Panmure Gordon, thanks very much for joining me today.
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