The past year has been eventful for oil..Markets have been volatile, moving up sharply to $120 per barrel, then retreating later in the year back to the $70 range before recovering to $80 in January. Price aside, oil is perhaps the most broadly utilized commodity in the world, driving strategic outcomes and responsive to others..While there never was any doubt, except in the minds of activists and purveyors of fairy tales, the demand for oil rebounded this year from its decline in 2020 and 2021. Consumption worldwide is now again reaching 100 million barrels every single day of the year. Perhaps this has reinforced the vital long-term importance of oil to some of those who heretofore have taken it for granted..Its degree of elasticity has been further clarified. For most of its uses, oil demand is built into today's modern world in ways that are slowly becoming better understood. The book How the world really works, by Manitoba professor emeritus Vaclav Smil is a must-read for those who really want to know. A skeptic of the rapid transition to a clean/green energy source, he writes: “Complete decarbonization of the global economy by 2050 is now conceivable only at a cost of unthinkable economic retreat.”. Vaclav SmilVaclav Smil, quoted, is sceptical about the prospects of clean/green energy replacing oil and natural gas in the foreseeable future. .Smil is one of many who believe there are no reliable alternatives to fossil fuels that are economically viable, effective, or possess comparable energy density. Smil and many others remind us by 2050 they will still occupy a high percentage of our energy sources. Over decades, oil consumption has been highly correlated with increasing population and economic activity. When the economy was virtually shut down for almost two years, the reduction in demand for oil, while devastating for the industry, was amazingly resolute and confirmed the foundational role it plays in our modern economy..Smil reviews it in detail and concludes this component of demand is inelastic. That oil prices responded to economic circumstances was also highlighted, demonstrating a degree of elasticity for limited, but important barrels. Commodities adjust to the price of the most recent transaction — the COVID period further reinforced the truism that “commodities are priced at the margin.”.According to OPEC, oil demand increased by 2.64 million bpd, or 2.7% in 2022. This is lower by 460,000 bpd than a previous forecast, largely a result of continued economic and health issues in China..OPEC sees demand exceeding 102 million bpd in 2023, higher than pre-pandemic demand in 2019. The US EIA (Energy Information Agency) is forecasting 101.03 million bpd in 2023; a similar forecast by the IEA (International Energy Agency) to average 101.3 bpd in 2023. The demand delta among the forecasts is only a million barrels, or 1%..The Energy Information Agency (EIA) a is forecasting global PRODUCTION of 100.7 million bpd this year. The International Energy Agency (IEA) 2023 forecast contemplates a tightening market as Russian production declines, suggesting another price rally. Often overlooked, production suffers “natural declines,” about 6% on average (except for the oil sands), meaning capital is required for production levels just to stand still..The Organization of Petroleum Exporting Countries (OPEC), dominated by Saudi Arabia and Russia, meets regularly. Within the past year it reduced the production quota in place, correctly anticipating market softness. Responding to the political disaffection in the US during an election year, President Biden visited Saudi Arabia to request more production. This was instead followed by a further production cut to a total of 2 million bpd from previous allocations. In fact, most OPEC members are producing flat out, some struggling to replace declines, and the consortium consistently under produces its nameplate quota..The production story for most of the last decade is the incredible growth of production in the US, primarily from the Permian — the marriage of an extensive resource play and continued evolution of horizontal multi-frac technology. In recent years many described the US, the world’s largest producer then approaching 13 million bpd, as the new “swing producer.” That characterization was a bit hasty as production in the US at the end of this year was in the 12 million bpd range, and unlikely to grow much in 2023 — a combination of investor expectations for the industry favouring cash flow versus growth, and the reality that peak production may be near in the Permian, following most other basins in the US.. Oil chart .Perhaps the most significant unknown variable is the economic collapse of China, at least by the standards of its recent incredible growth rate. For years China has been the largest importer of oil in the world, and also the second largest consumer. Will China return to substantial rates of growth, and if so, will that begin in 2023? Our previous commentary suggests not..The G7 nations — Canada, France, Germany, Italy, Japan, the UK, and the US — agreed to a $60 a barrel cap on the price of Russian crude oil. This unprecedented sanction on one of the world's largest oil producers is obviously a result of its invasion of the Ukraine. The impact of the cap is difficult to predict, and how this will play out is not clear. The market finds ways to match those with something to sell and those in need — supply and demand. Currently Russia exports about 3.1 million bpd as well as another 1.3 million bpd of refined products. Losing Europe as a customer, it redirected exports to India and China. The current realized price for Russian Ural, a blend of heavy sour and Volga light, usually trades below the $60 cap price. Maybe the cap is a non-issue? But it's certainly one more indication the war is a strategic blunder that portends a bleak outlook for Russian oil and gas over the long term..Currently it seems the intention of the cap is in part to deny INSURANCE AND TANKER CAPACITY to dissuade transactions. Russian oil will likely find a home, but at discounted prices. A Russian dream supply arrangement has been busted..Another variable is refining capacity. The US has historically been the largest global refiner, processing about 18 million bpd of crude oil into gasoline, jet fuel, diesel, and other products for domestic use and export. As refineries have become older and additional facilities less welcome, reduced capacity in the US is being replaced elsewhere..Rystad Energy, a Norwegian consulting company, is forecasting increased refining capacity of 3 million bpd in Asia, 2.3 million in the Middle East, and 2.2 million in Africa by 2025. The current Democratic political imperative to reduce US oil production and refining capability is another strategic blunder introducing unnecessary security and price risks to the world’s energy superpower. This a longer term issue with potential significant geopolitical ramifications..Meanwhile, Biden was still selling strategic petroleum reserve (SPR) oil in December, averaging almost 1 million bpd for the last seven months. With the goal to moderate gasoline prices into the November elections, this successful political strategy traded off the security of supply objective of the SPR for short term political gain..This leads us to another unquantifiable risk — the determination of much of the western world’s political leadership to undermine the production of fossil fuels. After investment of almost $4 trillion in so-called renewables, fossil fuels still source over 80% of the world's energy. Coal plants, the highest emitters of greenhouse gases, are still opening in China and India, two of the three largest emitting countries in the world. It's difficult to forecast the negative impact of the stupidity of discouraging production in the face of increasing demand..WTI, the US marker price, adjusts on the way to Canadian price discovery. First comes the lift from the weaker Canadian dollar, then discounts theoretically based on transportation costs. In fact, discounts are also determined by specific dynamics impacting each discrete flow of oil defined by its “weight” (light, medium, heavy, etc,) its “content” — sweet or sour (sulfur and other contaminants), transportation issues and costs, and local issues..For example, the recent Keystone Pipeline spill increased the discount (differential) of whatever stream of crude is backed up as surplus oil moves into storage. As the SPR mostly medium crude draws flood the market, there is downward pressure on prices for Canadian medium producers, increasing the differential. Similarly, the recent low water level of the Mississippi River backed up oil delivered by barge, reducing demand, increasing the “diff”, and reducing realized prices in Canada..What can we conclude as we draw all this together?.Most forecasts for 2023 oil prices are more positive than negative. Tailwinds are numerous, including pent up demand in China, the Russian oil cap, termination of the SPR draws, OPEC restraint and low inventories..Major uncertainties include economic outcomes impacting demand at the margin, unpredictable political agendas, geopolitics including war, and continued high levels of volatility..It's likely, given all the above, that oil prices will strengthen in 2023 and beyond. OPEC is predicting daily demand to exceed 105 million barrels by 2025, and that fossil fuels will still supply 70% of global energy demand in 2045. It's also likely the importance of North America as an oil supplier will decline as progressive governments suppress reserves development and production..The longer term result for us will be unnecessary relative economic decline and reduced capability in both Canada and the US to support energy security. Global leadership of the world’s most important commodity is being squandered as ideologues ignore the lessons from the German energy debacle..Oil is wealth and power. All this is the result of the notion humans can and should manage the climate..What is progressive about that?
