Tanker market faces crunch time
That was the sobering message from John Kemp, senior market analyst at Reuters, speaking at the Baltic Exchange Tanker Market Insights Webinar as part of International Energy Week.
Laying out the evidence to attendees, Kemp said that everything points to oil prices continuing to rise and continuing to add to inflation. This, he said, raises the key question: can the US Federal Reserve engineer a soft landing akin to a mid-cycle slowdown, avoiding a hard landing and an end-of-cycle recession?
He noted that soft landings are very hard to achieve, and that “obviously nobody wants a recession”, but past experience strongly suggests that a recession or at least a quite significant mid-cycle slowdown will be needed to rebalance the market.
Addressing oil prices, production and supply in turn, Kemp noted that oil prices rebounded extremely strongly after the Covid-19 recession. In real terms, prices are now at their highest level since 2014. But he pointed out that taking a historical perspective, while prices are high they are not “extremely so”.
Illustrating this with a chart plotting the frequency distribution of Brent crude prices since 1990, Kemp said prices today are around the 60th-80th percentile depending on what time horizon is used for evaluation.
Noting the cyclical nature of oil prices, Kemp said the Q2 2020 slump in prices as a result of Covid-19, the subsequent recession and lockdowns gave way to an equally strong rebound at the early part of 2021. “Prices for some months were up over 150% year-on-year,” he said. And though the rate of increase is slowing, prices are still currently up around 50% year-on-year. “The reason for that is that consumption fell much earlier and faster and has recovered more rapidly,” he said. Production, meanwhile, has lagged behind both during the downturn and the rebound.
The result of this imbalance was a massive production surplus during that first Covid-19 wave and the lockdowns; according to Reuters data, stocks were growing at over 18 million barrels a day in Q2 2020. But that was followed by a huge production deficit – since then, the market has been in deficit every month, bar in June 2020. This led to a massive inventory accumulation of about 1.2 billion barrels between January and May 2020.
Now, noted Kemp, inventory is back to roughly the same level seen at the end of 2019 – a time seen as a relatively tight market.
Turning to the advanced economies of the OECD, the picture is also one of persistent depletion. “The OECD inventory depletion is the largest and fastest that we’ve seen in decades,” Kemp said, adding that market has been consistently under supplied since June/July 2020. Today, these inventories are at very low levels. OECD inventories ended 2021 at their lowest seasonal level since 2013. “Clearly, a continued inventory drawdown at this rate is unsustainable,” he said. Reuters data revealed that OECD inventories are now about 8% below the pre-pandemic five-year average.
Kemp noted that rapidly rising spot prices and evident backwardation are classic indicators that the oil market is moving rapidly towards a cyclical peak. “The question is whether that is a short-term peak, where we might see a pullback for a few days or weeks, a medium-term peak that might last for a few months, or if we’re heading towards some kind of long-term peak in crisis,” he said.
Adding to the tight market, consumption is still “some way below” the pre-pandemic trend. By the end of the year, the US Energy Information Administration has forecast that there will be just under 103 million barrels of consumption per day in December. “If we’d stayed on the pre-pandemic trend, we’d have been over 104 million, so global consumption is still below trend.”
Kemp outlined four scenarios that could increase oil production: faster growth in OPEC output, faster growth from US shale producers, an increase in production from the non-OPEC producers, or a relaxation of US sanctions on Venezuela.
Slower growth risks
On the consumption side, Kemp presented four scenarios that could slow consumption growth: higher oil prices begin to restrain demand, a spontaneous slowdown in the business cycle easing the growth in oil consumption, the US Federal Reserve aggressively raises interest rates to force a cyclical slowdown, or China – the world’s largest oil importer – could experience a cyclical slowdown in 2022-2023.
“Some or all of these scenarios must occur at some point during the next two years in order to bring the oil market back into greater balance,” Kemp said.
From the four scenarios, Kemp spotlighted the possibility of a business cycle slowdown. In an examination of US consumer prices and inflation, he reported that core inflation is running at its fastest rate since 1993. That problem has already forced the Federal Reserve to shift its focus from supporting recovery and job growth to controlling inflation. “Inflation has been accelerating. The Fed hoped that it would be transient, but some of those inflationary pressures are now threatening to become more permanent. And past experience strongly suggests that upward pressure on prices is only likely to intensify as the business cycle matures,” Kemp said. He pointed out that the Fed has fallen behind in raising interest rates and that financial markets now expect the Fed to raise interest rates by a total of about 150 basis points before the end of 2022. That is equivalent to six quarter point rises before the end of the year.
The US Treasury yield curve has, in the past, been a pretty good predictor of both the end of cycle recessions and mid-cycle slowdowns. That curve is now starting to flatten which strongly suggests that the market is going to move into a period of slower economic expansion, Kemp said. “The real question is whether or not that is a recession which will bring this economic expansion to an end, whether it will be something more like a kind of mid-cycle slowdown we saw in 2015/2016, or what we saw in 1998/1999.”
Source: Baltic Exchange