Once upon a time, the oil market was highly seasonal, with the second and fourth quarters having the weakest demand during the year, and the second quarter especially, when refineries went into maintenance ahead of the summer driving season. The market typically saw demand for crude oil drop sharply. As the figure below shows, U.S. sales of middle distillate—diesel fuel and heating oil—used to peak in mid-winter about 1.5 mb/d above summer time lows. Although monthly data for Europe and Japan are not readily available from the 1970s, the two combined probably experienced something on the order of 1 mb/d swing from trough to peak.
The decline of seasonality and the ongoing recovery of global oil demand from depressed pandemic levels means that there will not be a large drop-off in demand for OPEC oil. The figure below shows the IEA’s forecast of demand for OPEC oil (plus stock change) and it indicates that the usual second quarter pressure on OPEC is unlikely to occur this year.
That said, there are a number of developments that could see the second quarter market weaken to a dramatic extent, particularly from the current elevated (near $100 Brent) level. First, but probably less likely, the weakening of pandemic restrictions could see a new wave of covid depress economic activity and demand. A new variant is possible, but the likelihood is unclear. At any rate, the possibility of an additional 0.5 to 1 mb/d of inventory build would not create major pressure on prices, given that stocks are depleted, somewhere around 500 million barrels. Lower demand of 1 mb/d for a quarter would reduce pressure on prices but not cause a crash.
The near certainty, though, is that the U.S. Federal Reserve Bank will raise interest rates, at least ¼ and potentially ½ percent, which could trigger a stock market selloff and some economic weakness. A crash in equity prices and oil demand appears unlikely, but at the very least, it will have a secondary effect on oil prices, bringing them down slightly. (In fact, the interest rate rise could already be priced into the market, but overwhelmed by the Ukrainian situation.)
But, to paraphrase the Bible, geopolitics giveth and geopolitics taketh away. The whole arc of the Russia/Ukrainian situation is not clear, but it seems highly unlikely that there will be ongoing military action as late as April. If there is no disruption to Russian oil exports, as seems all but certain, and the front lines in the Ukraine stabilize (Putin announces “MISSION ACCOMPLISHED” but probably from behind his desk instead of the deck of an aircraft carrier.) Easily $10 of the current price is due to the Ukrainian situation, and maybe $20. And even if there is no clear resolution to the conflict, without an oil supply impact, crisis fatigue will set in and traders will sell off.
Finally, Geopolitics II, the Ayatollah Strikes Back. Lost to the daily news cycle are the ongoing negotiations over the JCPOA with Iran, where it increasingly seems as if there will be a new agreement, perhaps before the end of February (as some have speculated), but almost certainly by end-March. New oil exports from Iran—which says it can quickly add 1.3 mb/d to production and has a reported 80 million barrels in floating storage—will not immediately appear, but there will be a schedule, formally or de facto, for their return and it will reduce concerns in the market about potential tightening later this year. So, an immediate drop of maybe $5/barrel when an agreement is announced, but forecasters will probably lower their second half price expectations by $10, all else being equal.
Given my spotty short-term oil price forecasting track record (longer term is better), you might think I would be reluctant to commit a new forecast to print, but only if you don’t know me. (Either I’m shameless or figure one more miss won’t hurt my reputation.) I’m going to guess we’ll see Brent somewhere around $80 in the second quarter and $70-75 in the second half of this year. This assumes no major new covid wave, a Fed interest rate increase, stability in the Ukrainian situation by end of March, and a new JCPOA agreement with Iran. As they say, “Watch this space.”
