Oil market volatility: Assessing the bullish and bearish narratives

Volatility has been the name of the game in oil markets where we have recently seen some very sharp movements in oil prices and spreads. This reflects the high degree of uncertainty surrounding the oil market both on the supply and the demand side, but also lower liquidity which is amplifying some of these price movements. And these are reflected in two contrasting narratives: The super bullish scenarios which are projecting sharp acceleration in prices and focusing on the supply side of the market and the super bearish scenarios which are projecting a sharp decline in the oil price and focusing on the demand side and recessionary fears. This new OIES presentation empirically assesses these two narratives via forecast scenarios that attempt to stress test the upside and downside extremes of the short-term price outlook to 2023.

On the upside, the main elements of the bullish narrative are supply-driven in terms of Russian disruptions accelerating again in H2 2022 and persisting in 2023, some OPEC+ producers continuing to struggle returning production, geopolitical risks outside Russia persisting and Iranian production failing to return in 2022 and 2023, and non-OPEC growth continuing to undershoot expectations. From a demand perspective, gas-to-oil switching amid winter gas shortages and a stronger comeback of Chinese demand dictate the bullish narrative.

Analysis shows that even if all these bullish factors converge together to generate a perfect bullish storm, oil prices are not expected to exceed $140/b and they cannot be sustained in a strong price environment of $130s for more than two quarters due to strong negative responses from the demand-side. For prices to persist on an upward momentum, the eventual realization of the Russian disruption needs to be large, and one needs to make the unrealistic assumption that high prices due to the supply shock don’t have a substantial impact on demand.

On the downside, the main elements of the bearish narrative are demand-driven in the face of recession concerns amid persistent supply-chain disruptions and high inflationary pressures squeezing global growth. Bearish supply-driven pressures are also present in terms of a lower realization of Russian disruptions, a potential breakthrough in the Iran nuclear negotiations and the full returning of Iranian production, modest improvements in the non-OPEC outlook and an extension of the SPR releases to year-end.

Under a perfect storm of negative drivers, our modelled projections suggest that oil prices could fall in the $70s, but this will require all the negative demand and supply forces to converge together in a perfect storm including the Russian supply shock to be resolved and ignoring the impact of the low-capacity buffers in the oil system. This sets the price floor higher by between $5-$10/b in the $75/b and $85/b range.

Our reference outlook suggests that the oil market volatility will remain elevated and the eventual realization of the oil market will likely turn out to be somewhere between these two extreme scenarios as there are many moving parts shaping the market and not all of these moving parts can move in the same direction for long. Eventually as the dominant elements become clearer (i.e. the impact of sanctions on Russian production, macro-outlook and demand impacts), price volatility will start to ease and move away from the recent extremes.

By: Bassam Fattouh , Andreas Economou