Bilal’s Macroscope: Oil to $120?

No one is expecting much in oil markets in 2023. The consensus of analysts is for (Brent) oil prices to the end the year unchanged from current levels. A year ago, they were expecting a 17% drop – oil ended up surging to $120 in the first half of 2022. Meanwhile, investors have reduced their net long oil positions to its smallest size since late 2015. It appears then that the biggest shock of 2023 could an oil price surge. Not only would it surprise the market, it would wreak havoc on inflation forecasts and put central bankers in a bind. We think there are good reasons for oil to reach $100 or even $120 this year. Here are three reasons:

• Oil production surged in 2022, but it will be harder to see further production gains in 2023. Global crude oil production averaged c.82mn barrels a day (mbpd) between 2015 and 2019 – which captures the shale production boom and a ‘normal’ global economy. In 2020, oil production fell to 76mbpd – this was 7% below the average. 2021 wasn’t much better with production only increasing to 77mbpd. But last year, production surged to almost 81mn – a jump of 4.5% from 2021 levels and only 1% below 2015-2019 levels.

So which countries are producing less than before?

• Venezuela (1.8mbpdless than 2019)
• Iran (1.2mbpd less)
• Nigeria (1.1mbpd less)
• Mexico (0.9mbpd less)
• Russia (0.6mbpd less)

Many of these countries are sanctioned, and so the easy gains in production happened in 2022, and it will be harder to see meaningful gains in 2023

• Oil demand should pick up in 2023. US oil consumption is 1% below 2019 levels, European consumption is 4% below, and Japanese consumption is 12% below. Meanwhile, China oil imports are 5% below their 2020 peak and 13% below their pre-COVID trend. Indian imports are higher than in 2019, but they are 4% below their pre-COVID trend. Therefore, assuming some continued normalisation in oil demand in developed economies and a rebound in China growth, oil demand should be higher in 2023 than in 2022.

• The typical annual range in oil prices is 50% (of the average price) – that means it would be ‘normal’ to see either $42 or $117 trade this year. When looking at oil prices since 2000 – that is, since the rise of China – the average annual range of oil prices has been 51%. The biggest range year was 115% in 2020 and the smallest was 19% in 2013. In 2022m it was 54%. For 2023, we would err on the side of larger ranges thanks to potential large swings in demand (China re-opening or US hard landing) and continued geo-political risks (Russia). In any case, expectations that oil could bumble along current levels are likely mispriced.

Overall, the consensus is for a benign year for oil prices, but the fundamentals suggest otherwise. We think the risks are a ‘surprise’ move towards $100bbl or even $120bbl. And this could prove problematic for both policymakers and investors.

Our Current Discretionary Trades

Last week, we published our favourite trades to start the year. They remain unchanged:

DM

• Rest of the world catch-up: long EUR/USD (target: 1.12) and short USD/JPY (target: 125)
• UK rolls over: UK 2s10s steepener (target: 70bp)
• Euro (bond) supply issues: sell BTP vs bund 10Y (target: 250bp)
• Aussie rebound: sell GBP/AUD (target: 1.70)
• Too much Swedish love: receive Swedish vs Euro area 2Y swaps (target: 50bp)
• No time for tech: long SPX vs Nasdaq

EM

• EM FX crosses: long THB/TWD (target: 92)
• China reopening: short USD/CNH (target: 6.75),short USD/CLP (target: 820), long HSI (target: 21,000)
• EM rates rally: receive 1s5s MYR IRS (target: -10bp)

What Are Models Signalling?

It is nice when models provide a similar signal to your own view. However, this is not always the case. That’s the great thing about investing, it is a challenge. Here are the latest (dis)agreements:

• The latest CFTC positioning is coming around to our view: long EUR and JPY (vs USD), as are our FX carry strategies.
• Momentum models have turned net-bullish on US rates. In contrast, we are reluctant to position for further bullishness, here’s why.
• Remaining in rates, our rates PCA model has stopped highlighting UK 2s10s steepening. Meanwhile, Henry thinks there remains room for this to perform given we expect BoE dovishness and very heavy gilt net-supply.

Recent Questions From Clients

• What do we need to see to know US growth will bounce?
• Why is core services ex rent so low?
• Will the BoJ exit YCC in March?
• What is biggest risk for 2023?
• Will China invade Taiwan?
• Will 2023 be more of range year?

What I Am Reading

• Drone Photographer Captures Rare Footage of Moose Shedding its Antlers
• 14 Awesome-Sounding Genre Films Coming to Sundance 2023
• A Detailed Documentary Traces the Process of Making Artistic Manhole Covers in Japan
• These Gorgeous Photos Capture Life Inside a Drop of Seawater
• ChatGPT in an iOS Shortcut — Worlds Smartest HomeKit Voice Assistant

Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)