Oil Heads for First Annual Decline Since 2020 as Oversupply Weighs

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Oil prices are on pace to decline around 10% in 2022, which would mark the first annual drop since the pandemic-driven crash of 2020. After a volatile year, bearish sentiment has taken hold in oil markets amid fears that surging production outside OPEC will lead to an oversupplied market.

With the global economy slowing, especially in key consumer China, demand growth is stalling. Meanwhile, output has hit new highs in the United States, Brazil, Guyana and other non-OPEC countries. This perfect storm of sluggish demand and robust non-OPEC supply has tipped the balance into surplus, putting downward pressure on prices.

West Texas Intermediate futures are trading near $72 per barrel, down from over $120 in June. The international Brent benchmark is hovering under $78, having fallen from summertime highs over $130. Despite ongoing risks, including escalating Iran-related tensions in the Middle East, oil is poised to post its first yearly decline since the Covid crisis cratered prices in 2020.

Supply Surge Outside OPEC Upsets Market Balance

Much of the extra crude swamping the market is coming from the United States. American oil output averaged 13.3 million barrels per day last week, a record high. Exceptional production growth is also happening in Brazil, Guyana, Canada and other countries.

The International Energy Agency expects this non-OPEC supply surge to continue, forecasting growth of 1.2 million barrels per day next year. That will more than satisfy the world’s modest demand growth projected at 1.1 million barrels per day in the IEA’s base case scenario.

With non-OPEC, and chiefly U.S. shale, filling demand, OPEC and its allies have lost their traditional grip on balancing the market. Despite cutting output targets substantially, OPEC+ efforts to lift prices seem futile.

Traders anticipate more discipline will be required to bring inventories down. But further significant cuts could simply provide more space for American drillers to increase production, replacing any barrels OPEC removes.

Tepid Demand Outlook Adds to Gloomy Price Forecast

On top of the supply influx, oil bulls are also contending with a deteriorating demand environment. High inflation, rising interest rates, and frequent Covid outbreaks have slowed China’s economy significantly.

With Chinese oil consumption dropping, global demand growth is expected to decelerate in 2024. Major financial institutions like Morgan Stanley see demand expanding at less than 1 million barrels per day. That’s about half the pace forecast for 2023.

Other major economies in Europe and North America are also wobbling, further dampening the demand outlook. Less robust consumption, together with the supply deluge, points to a market remaining oversupplied through next year.

In futures markets, bearish sentiment has sunk in. Both WTI and Brent futures point to prices averaging around $80 per barrel in 2023, barring a major geopolitical disruption. That would cement the first back-to-back years of oil price declines since 2015-2016.

Wildcard Risks – Can Middle East Tensions Shift Momentum?

As oversupply dominates, the greatest upside risk to prices may be conflict-driven outages that take substantial oil capacity offline. Heightened tensions between Iran and the West pose this type of wildcard geopolitical threat.

Recent attacks on oil tankers near the Strait of Hormuz and Arabian Sea occurred after the U.S. killed an Iranian commander. Iran-backed Houthi rebels in Yemen also launched missiles and drones at facilities in Saudi Arabia.

While no significant disruptions have occurred so far, direct hostilities between Iran and the U.S. or its allies could sparks clashes endangering Middle East output. Iran has threatened to blockade the Strait of Hormuz, which handles a fifth of global oil trade. Any major loss of supply through this chokepoint could upend the bearish outlook.

For now, however, the market remains fixated on bulging inventories and the supply free-for-all outside OPEC. As the world undergoes a historic shift in oil production geography, the industry faces a reckoning over whether unchecked growth risks unsustainably low prices. If the supply surge continues outpacing demand, today’s pessimism over prices could last well beyond 2024.

Take a look at more emerging growth energy companies by taking a look at Noble Capital Markets’ Senior Research Analyst Michael Heim’s coverage universe.

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