Geopolitical and economic headwinds are likely to persist into the first quarter, industry experts say.
By Keith Reid
High prices for crude oil and fuel continue to be a tremendous issue throughout the world, driving inflation and impacting global markets amid Russia’s continued war in Ukraine and economies that are still trying to recover from the pandemic.
Fuels Market News interviewed three industry-focused oil and fuels analysts to discuss some of the factors that readers should watch for in the coming months. All were quick to point out that we are living in unusual times right now, making traditional forecasts difficult. All indicated little expectation of major changes in the status quo in the first quarter of 2023, barring extraordinary circumstances. However, they did offer some input on the various factors readers should be watching for as things develop.
Crude Oil
The core component of refined product prices is typically linked to the price of crude oil, which was averaging in the $90 range at press time. This is down considerably from the peaks over $120 per barrel immediately after the Russian invasion of Ukraine. However, prices have stalled due to several supply and demand factors.
On the supply side, the industry was still recovering from the impact of the pandemic-related oil glut that saw prices plummet (even going negative for a short period), severely financially damaged many producers and hurting investors. Demand and supply were recovering, and then the Ukraine disruption occurred.
The resulting sanctions on oil-producing Russia substantially impacted Europe’s natural gas and refined product supply and disrupted global crude supplies. This has been gradually working itself out. Russia has so far been able to find alternative markets for much of its crude though sales to China, India, Turkey and even Saudi Arabia (though at lower volumes and discounted prices). The United States began to adjust its exports to fill European needs, and the Biden Administration began drawing down the Strategic Petroleum Reserve.
However, there was a lack of aggressive, extra production in regions like the United States to quickly ramp up supply. Further, OPEC+ in October 2022 agreed to production cuts of 2 million barrels per day, though that is not always set in stone.
“There’s a lot of difference between what [OPEC+] says and what the realities are,” said Alan Levine, founder and CEO of the hedging advisory firm Powerhouse. “We have a lot of serious uncertainties overseas, obviously, and we’ll see what emerges as the Saudis look for a new position for themselves in the world. There’s even talk that their ability to produce is somewhat strained as well.”
The rationale for the OPEC+ cuts is straightforward.
“OPEC is saying that they made this cut because they see lower demand growth going forward from global economic issues,” said Brian Milne, energy editor and a product manager with DTN. “What they’re really trying to do is support oil at around $90 a barrel. Will they be successful? Demand can come. Or, when you start seeing demand drops and people lose confidence in the market, you could really see prices just plummet despite those cuts if you didn’t make them in time.”
Several of the analysts noted that the administration’s decision to refill the depleted Strategic Petroleum Reserve at $70 per barrel effectively sets a floor on how low prices can go.
U.S. fracking producers have also been hesitant to ramp up significant production to levels demanded by the Biden Administration, despite accusations of price gouging, threats of windfall profit taxes and favorable current oil prices. There are several factors at play.
“In both Europe and the United States, policy has been going against fossil fuels,” said Milne. “The restrictions on investments, the inability to get certain pipelines approved—in recent years that’s been a disincentive. Not to mention a number of the bigger banks have discouraged any sort of investment in oil production—the whole ESG thing.”
The focus on a future green economy and discouraging investment in traditional fuels is not all that’s impacting increased production. Since the beginning, fracking has involved regular cycles of both boom and bust (and, as already noted, the pandemic was a recent, huge bust period), and there finally appears to be some discipline in the industry.
“You’re hearing a lot of drillers have cleaned up their balance sheets,” Milne said. “They got rid of the debt because they’ve followed this process. That’s why if you look at crude production, it really hasn’t grown this year despite the high prices. So, what you’re seeing is more discipline, not just because of the Wall Street demands but also looking out and saying we want to preserve our reserves.”
What would happen if the war in Ukraine was suddenly decided with complete success for the West, causing sanctions to ease?
The bullish possibility is that all’s right with the world, traditional flows could resume, and buyers could seek to reestablish traditional relationships, Levine said. “Short-term demand from Western buyers boosts prices. Generally, good news encourages optimism and boosts prices. The bearish possibility is prices fall because of a reduced fear premium. No Putin, no dirty bomb and the potential for more Russian output. Demand for war goods, including jet and diesel fuel, falls.”
That leaves the demand side, where the “good” news is anything but good. The health of the global economy (and the U.S. economy more domestically) is likely the major issue weighing on where prices go moving forward.
Milne noted that the United States was in a recession in the first half of the year. “We saw some better growth than anticipated in the third quarter, but there are already signs of struggle,” he said. “Do we flip into negative growth in the fourth quarter? Maybe, maybe not.”
The situation is equally grave, if not more so, globally.
“It’s looking like a global recession is coming, and it’s hard to get out of this box now because you’re seeing inflation pressures,” Milne said. “There are some numbers that just came out from Germany and Italy showing high inflation. So, Europe is stuck in there. We know the U.S. still has high inflation, and the response is going to be through interest rates, and that’s going to curb the demand side.”
Milne noted crude price predictions range from Citibank projecting $65 per barrel WTI (based on predictions of a global economic recession), to Goldman Sachs and Bank of America anticipating $135 per barrel. He sees a price from $70-$85 or so a barrel as more likely going into 2023.
Diesel and Gasoline
Diesel is under significant pressure globally. Europe lost imports from Russia, there have been refinery strikes in France and a number of refiners have converted from conventional to renewable diesel. The United States has fared better, overall, but is facing some significant logistical issues with diesel on the East Coast.
“Inventories are terribly tight, and the mystery in all of this is we’ve got available crude oil to where we are exporting it,” Levine said. “And refinery operations are still in the upper 80s [percent] of capacity, so you’re still getting reasonable runs. But despite all that, we simply have been incapable of building inventories.”
A particular concern involves heating oil, which is essentially ultra-low sulfur diesel and remains a primary heating fuel in the Northeast. A cold winter would strain the market, while a warm winter would ease the situation. The weather is impossible to predict with complete certainty, but forecasts are encouraging so far.
“I think we get through this, because it sounds like the weather forecasts are actually trending a little bit milder than originally anticipated,” said Denton Cinquegrana, chief oil analyst for OPIS (A Dow Jones Company). “So that should help in the long run.”
Diesel prices work as an inflation multiplier since they ultimately impact the price of everything that moves on a truck or train. They are also supported by the state of the general economy.
“If we have a recession, the economic machine runs on diesel, and we’ll lose some of that diesel demand, and it will allow inventories to build up,” said Cinquegrana. “But you don’t want to get to a recession to help supplies and destroy demand. I think that’s going to be a big specter hanging over the market for probably the next six months or until the Federal Reserve really stops or slows down some of the interest rate hikes.”
Gasoline prices are likely to have moderating impacts coming up. Winter will naturally drop demand, and there have been no major hurricane disruptions in the Gulf.
“We don’t anticipate much of a problem with gasoline, at least in the next several months,” noted Levine. “There may be some support because there’s a certain amount of winter turnaround, which is now going on. But nothing to cause a serious concern.”
Levine raised the point that the U.S. still has strong exports of both crude and distillates, and he wonders about the coherence of the policy supporting those exports.
“It’s hard to understand what policy we seem to be pursuing,” he said. “So, we empty out the petroleum reserve and send it overseas—that’s a little bit of a simplification, but still. And last week we exported 1,200,000 barrels [of distillate] a day, and it all detracts from the available pool for the United States.”
While an export ban would likely have an impact on diesel prices, Milne is not sold on the idea. “Short term, it would offer some relief for prices, but we would see Gulf Coast refineries starting to reduce runs. They would bring it in because they’re not going to be able to get the supply out.”
As with diesel, logistics pose challenges in the U.S. in moving product out of the gulf with pipelines at capacity. One logistics cure that is raised regularly when such disruptions occur is a temporary moratorium on the Jones Act. The act, dating to 1920, requires that only U.S. flagged ships carry cargo between ports. Diesel refining capacity is down on the East Coast, and the pipelines carrying refined products to the coast are nearly at capacity. So are the coastal tankers.
“Even if it’s a short-term waiver of a couple months to move diesel and gasoline from PADD3 to PADD1, I think that would really help in the short term,” said Cinquegrana. “I think Valero suggested this in their recent quarterly call, a short-term waiver on the gasoline sulfur specifications. We export a lot of gasoline because there’s a portion of it that doesn’t meet U.S. specifications.”
Backwardation, where the current spot price is higher than prices trading in the futures market, has been excessive. This also impacts building supply. “This strong backwardation, say 50 cents, provides absolutely zero incentive to bring barrels into the terminal, into the storage tanks and hold them in,” said Cinquegrana. “So how do I build up inventory when there’s no incentive to store? You don’t have to reverse to contango [roughly the opposite of backwardation]. You need it to at least normalize to a point where it’s a couple of pennies of backwardation. I think the backwardation theme is going to be a big deal … into the new year, and if it stays like this it’s going to make it very complicated for supplies to normalize.”
With all the current challenges the bad news is that there is not likely any “silver bullet” solution that will solve things overnight. Similarly, there is not likely a super threat that will explode prices. More of the same seems to be the most expected outlook on fuel prices. And, hopefully, we don’t have to rely on a drastic global recession to see cheap fuel again in 2023.
Keith Reid is the editor of Fuels Market News
