Can This Oil Rally Sustain into 2023? Some Analysts Think So

Oil prices are attempting to extend the ongoing relief rally this week after closing over 4% higher last week. On Thursday, the prices extended gains for the fourth consecutive day amid tighter supplies of U.S. crude and heating oil.

The rise in oil prices comes after the new government data showed a bigger-than-expected decline in U.S. crude inventories to 5.89 million barrels for the week that ended on December 16. Furthermore, inventories of distillate stocks including jet fuel and heating oil also tightened, also contrary to analysts’ expectations.

The stockpile drop follows recent weather forecasts indicating that a severe storm is expected to hit the United States. The weather reports predict sub-zero winds in Texas as well as record-low forecasts for Florida and eastern states.

Demand for jet fuel is also expected to increase amid a travel boom ahead of the holiday season. However, transport fuel consumption could retreat if the storm weighs on travel demand.

China Dismisses Oil Price Cap

Elsewhere, independent oil refiners in China are generating increased profits from processing low-cost Russian oil as the West’s sanctions targeting Moscow give them leverage to negotiate for significant price discounts, according to industry insiders.

G7 member nations imposed a ceiling price of $60 a barrel for Russian oil as of December 5, while the European Union (EU) introduced a ban on Russia’s seaborn imports to restrict Moscow’s war funding efforts in Ukraine. As a result, Russia is redirecting its crude from the West to Asia at cheaper prices.

China continues to purchase Eastern Siberia Pacific Ocean (ESPO) crude above the price ceiling as the country’s independent refiners prefer shorter shipping distances and low-sulfur quality, according to traders.

Meanwhile, India is getting Russian Urals crude at steeper discounts of below $60 per barrel. Commodity trading activity suggests there is no proper replacement for similar quality oil to Russian ESPO crude at more affordable prices.

EU energy ministers came to an agreement on Monday to cap natural gas prices at €180 per megawatt hour, though the European Commission (EU) warned that the cap could be revoked if “risks outweigh the benefits.” The price ceiling came just a couple of weeks after oil prices were capped at $60 per barrel.

Can This Oil Rally Sustain?

Commodity bulls are now hoping that the ongoing move higher in oil prices could sustain into 2023 amid falling supply and expectations that the winter in the U.S. and Europe will get more severe. Earlier this week, S&P Vice Chairman Dan Yergin said he anticipates oil prices to jump to $90 per barrel in 2023.

Yergin believes that prices could even hit a whopping $121 a barrel when China fully reopens from Covid lockdowns, though there are still major uncertainties surrounding the oil market, he added. These uncertainties include the U.S. central bank’s decisions, China demand, and Russia’s reaction to the imposed price caps.

“Our base case for 2023 is $90 for Brent but you have to look at other cases. If China gets over Covid ... then you add a lot of demand to the market,” Yergin said.

The reopening in China could provide a “big boost” to oil prices and drive them to $121 per barrel, helped by underinvestment in oil and gas, he added. Then again, factors such as the likelihood of an economic recession could push the prices down to $70 per barrel.

According to S&P’s latest forecast, oil demand in China could hit 15.7 million barrels per day next year, which would represent an increase of 700,000 barrels compared to 2022.

On a similar note, Eric Nuttall, partner, and senior portfolio manager at the alternative investment firm Ninepoint Partners said he expects oil prices to hit $100 a barrel in 2023.

The forecast comes as multiple headwinds that have contributed to a decline in oil prices this year such as China’s stringent zero-Covid policy and coordinated Strategic Petroleum Reserve (SPR) releases are expected to stop next year.

This, along with Western sanctions on Russia’s oil and gas, is likely to raise oil prices, Nuttall noted. He also thinks the energy market will continue to outperform other sectors due to strong demand.

Bank of American analysts provided a similar outlook last week, estimating that oil prices could surge beyond $90 per barrel, boosted by a looser monetary policy by the Federal Reserve and China’s economic reopening.

“Our oil demand and price projections for 2023 rely heavily on robust China and India demand growth, so any Asia reopening delays could affect our expected price trajectory,” analysts wrote.

Summary

It is looking increasingly likely that commodity analysts and investors agree that there is a structural supply side underinvestment, which could help drive oil prices higher in 2023. Tight supply, as well as potential China reopening, are poised to maintain oil’s status as an attractive alternative investment. Oil prices have traded higher in the last 10 days with crude oil prices trading over 12% higher relative to the 2022 low set earlier this month.