Since the beginning of 2021, the price of Brent crude oil has risen by 38%, while oil demand still has not recovered to pre-crisis levels.
The main question that comes to mind is whether current oil prices are sustainable. We believe that answer is ‘yes’:
- OPEC+ is determined to keep prices high. There is no strong motivation for another oil price war due to the US’s reduced output. In addition, OPEC+ countries need higher oil prices to break even fiscally
- Historical evidence suggests that there is potential for a strongly positive surprise. In past cases of oil futures curve backwardation, the spot oil price for the next three years has outperformed the oil price expected by the futures market by 60%+ on average. This has been so in 45% of all cases.
OPEC+ will likely continue to support the oil price at a level of USD 60-65 a barrel (bbl)
The trigger for another oil price war is absent
During the last 10 years, Saudi Arabia has initiated two oil price wars, both of which were targeting the shale industry. During the first war in 2014-2016, its objective was to interrupt the development of the US shale sector. During the latest conflict in 2020, Saudi Arabia tried to stop the US from filling the supply gap due to the output cuts imposed by OPEC+. Russia’s reason for leaving the OPEC+ agreement in March 2020 was that instead of cheap Russian and Saudi Arabian oil, expensive US shale oil was coming on to the market. Currently, the situation is different. US oil producers have claimed that they are not going to speed up output growth, but will instead choose to pay their debts. A large share of US oil industry debt will mature in 2021-2022. This will likely lead to more cautious capital spending in the medium term. According to the EIA, the US output forecast for 2021 was downgraded to 11.01 million bbl/day, thanks to the shutdown of the oil industry in Texas in February among other factors.
ESG initiatives are pressuring the US oil output
US President Joe Biden’s green initiatives will likely slow down the recovery of US oil output. The administration says the US will make the most aggressive carbon cuts it possibly could. Biden plans to move to a carbon-neutral energy system by 2035 and his early moves show his actions are being aligned with this goal. On the first day of his presidency, he pulled the permit of the Keystone XL pipeline, the project that was supposed to be delivering as much as 830 thousand b/d of crude oil from Alberta’s oil sands. Environmentalists are now pressuring him to take action against Energy Transfer LP’s Dakota Access oil pipeline and Enbridge Inc.’s plan to expand its aging Line 3 pipeline.
Moreover, the US president has signed a bill suspending new oil and gas leases on public lands. This includes the large Permian shale basin in New Mexico. About 22% of US oil production and 13% of gas production occurs on federally owned land. This could shrink US oil production by two million barrels per day by 2024, according to S&P Analytics.
These factors lead to lower potential oil output by the US, which is a factor supporting oil prices. Thus, there appears to be no big threat from the US to OPEC+.
OPEC+ members are motivated by their budgets
Additionally, OPEC+ members are keen to keep oil prices high for budget reasons. According to the IMF, the export-weighted OPEC breakeven oil price is USD 91/bbl on average in 2021. As a large player, Saudi Arabia requires oil to cost USD 76.2/bbl for its budget to break even in 2021. Russia needs oil to cost around USD 65.2/bbl. UAE’s 2021 breakeven oil price is USD 64.6/bbl, Iraq’s USD 71.3/bbl.
Graph 1. Projected oil exports and budget breakeven oil price by country for 2021
Sources: IMF, Bofit, Kommersant TKB Investment Partners; June 2021
Historical evidence hints potential for a strongly positive surprise
At the moment, oil futures prices have shifted into backwardation, meaning that near-term futures are traded at a higher premium than later ones. Statistically, the current situation allows for a strongly positive surprise. In similar situations in the past, the spot oil price for the next three years outperformed the oil price expected by the futures market on average by 60%+ in 45% of all cases. Please see our arguments in favour of such a scenario over the next three years in our recent white paper “Russian equities riding the long-term commodities growth trend”.
Table 1. Spot vs futures oil prices and the historical observations of the subsequent 36 months of oil prices behaviour
|Positive surprise||Negative surprise|
|Probability||Average effect||Probability||Average effect|
|Spot prices close to futures prices||67%||26%||11%||-11%|
|Spot prices higher than futures prices||45%||62%||33%||-24%|
|Spot prices lower than futures prices||75%||28%||25%||-26%|
Note: On the basis of data on Brent crude oil futures prices from December 1999 to the end of April 2021– Bloomberg ticker: COA Comdty, in USD terms. We calculated the average price for each futures curve priced at the end of every December from 1999 to 2020 and the latest available curve at the moment of computations. Averages were based on the prices along the curve starting from two months to 36 months. Then average spot oil prices were calculated over the same 36 month periods. To calculate the surprises, we looked at cases where the difference between the average spot prices and the average futures curves described above exceeded 10%. Thus if spot prices on average exceeded futures curve by more than 10%, that would count as a positive surprise. If futures prices on average exceeded spot prices by more than 10%, that would count as a negative surprise. Any difference below 10% was assumed to be a neutral effect. The probability of a surprise is the share of such surprise cases out of all observed cases. Then the average effect is the actual difference between spot and futures averages, meaning by how much spot price averages were higher/lower than futures price averages.
Source: Bloomberg, TKB Investment Partners; June 2021
Authors: Aleksandra Kuznetsova, Investment Specialist, Egor Kiselev, Head of International Business & Investment Marketing, Gennady Sukhanov, Deputy Head of Equities & Head of Research