Could Oil Prices Crash In The Fourth Quarter?

Although the futures strip doesn’t reflect it, many anticipate a much tighter oil market in the fourth quarter. Jeff Currie of Goldman Sachs has predicted that prices will reach $110 by the third quarter, in line with the IEA’s expectation that the market will tighten significantly then, as the figure below shows. Essentially, the world will need to either draw down inventories by 1.6 mb/d in the second half of this year, or OPEC+ must increase production by that much, or prices will rise if the IEA’s expectations prove out.

Ay, there’s the rub, as Hamlet said while barbequing. The IEA, like all others making short-term forecasts, has to make numerous assumptions about the behavior of various governments which greatly multiplies the uncertainty about the market balance. The table below shows the projected changes for the major variables. Most noteworthy: expectations of a decline in 1 mb/d from Russian oil, which is based on the assumption that sanctions and the price cap will reduce their sales. So far, that appears questionable, in which case the balance would be much less tight.

One little noticed development is the change in drilling in countries like Angola and Nigeria. Their production in January was 840 tb/d below their allotted quota, which has been a factor in supporting prices the past year. This is entirely due to low drilling during the pandemic, especially in Nigeria where drilling dropped from fifteen rig-years in 2019 to seven in 2021. As of January, the number of rigs had climbed to thirteen while Angola, where the number of rigs had averaged four for the past several years, now has nine operating.

This increased activity should restore some of the production lost since the pandemic; 2019 production levels were essentially the same as the current quota. Naturally, higher production won’t occur overnight and the total loss won’t be recovered completely in the short-term, but by the end of 2023, the two could see production 300-400 tb/d higher than now.

Add to that increased production from Venezuela, where Chevron has already boosted output by 40 tb/d to 90 tb/d, about half of capacity. Conoco, ENI and Repsol, other historical operators in Venezuela, have all made moves that could restore some of their operations. The ultimate impact could be an increase in Venezuelan production of another 200-300 tb/d by year’s end, although this could be optimistic. If the country can increase maintenance, even more could be produced but the political and legal situation does not auger well for this to occur, at least not quickly.

Finally, the Russian oil sector will be key to the market balance in late 2023. If Russian production ‘only’ declines by 400 tb/d, there will be little need for other OPEC+ members to raise production. Which is good, because it’s not clear whether they are willing to do so. If Brent rises $10/barrel, will the Gulf producers ramp up production? That would presumably require agreement from OPEC+ which might be difficult to achieve, but if the Saudis especially want it, then it would be hard for the others to prevent it. The Saudis are the irresistible force, and the others are more a stubborn object than an immovable one.

Making a moderately optimistic assumption about production from Angola, Iran, Nigeria and Venezuela, wherein production at year-end has risen by 600 tb/d, means that an additional inventories of nearly 100 million barrels. And if the third quarter Russian supply is assumed 500 tb/d higher than the IEA assumption for the third quarter and 750 tb/b higher in the fourth quarter adds another 120 million barrels to inventories, and the figure below shows that adjustment.

However, that also assumes all the extra supply goes to OECD countries, and since they consume less than half of the global total, it would not be unreasonable to adjust the numbers accordingly. In that case, OECD inventories would decline by about 100 million barrels by year-end. This seriously reduces the market tightness seen in the IEA assumptions, but doesn’t translate into a glut.

Still, there is an enormous amount of room for surprises on both the demand and the supply sides which could tweak the results rather substantially. The priority for market observers should be: Russian supplies, Chinese demand, and U.S. shale oil production, in that order, for where the oil market ends up. Absent strong demand or supply-side surprises, though, the market doesn’t seem likely to be exceptionally tight by year’s end.