The post-COVID rebound in economies and oil demand have left global spare oil production capacity at very low levels with a very small cushion to absorb possible supply-side shocks in the near term. Despite the economic slowdown already underway in many parts of the world and fears of recessions in Europe and the United States, oil prices haven’t fallen too far below $90 per barrel. Fears of supply disruptions have increased as much as fears of recessions that could slow oil demand growth.
The thinnest spare capacity cushion in years is supportive of oil prices and will continue to be a bullish factor on the market, at least in the short term, considering that no forecaster or analyst can be certain how much global oil supply will be lost in just three months when the EU embargo on Russian oil imports by sea enters into force.
Certainly, there is one sure-fire way for the world to see rising spare capacity and oil inventories rebuilding from multi-year lows to more comfortable levels—recession. A serious slowdown in economic activity or an outright recession would be needed to bring global oil stocks up to five-year average levels, as Reuters’ senior market analyst John Kemp notes.
And right now, it looks like a recession is the only way to rebuild global oil inventories.
On the supply side, neither OPEC+ nor the U.S. can materially boost supply in the short term. OPEC+ is estimated to be a massive 3.6 million barrels per day (bpd) below its targeted oil production. Moreover, global spare capacity is in the hands of just two OPEC producers, Saudi Arabia and the United Arab Emirates (UAE). The Saudis themselves admitted this week that the next rebound in economies would wipe out the spare capacity.
“Oil inventories are low, and effective global spare capacity is now about one and a half percent of global demand,” Saudi Aramco’s CEO Amin Nasser said this week.
“But when the global economy recovers, we can expect demand to rebound further, eliminating the little spare oil production capacity out there. And by the time the world wakes up to these blind spots, it may be too late to change course,” he added, reiterating the warning that years of underinvestment in oil and gas have brought about the current low spare capacity and tight markets.
At the same time, American oil executives say that the U.S. cannot come to the rescue for Europe this winter as oil and gas producers can’t ramp up current production levels too much to offset an expected drop in Russian oil supply when the EU embargo enters into force.
All this leaves the demand side to rebalance the market. If a severe recession with significantly slower oil demand growth or even a demand drop materializes, spare capacity and inventories could rise from multi-year lows.
A recession may be coming for the world in 2023 as central banks aggressively hike interest rates to tame inflation, the World Bank said last week. Just this week, the Fed raised the key rate by another 75 basis points for a third consecutive time, and the Bank of England raised rates by 50 basis points to 2.25%, the highest rate since the start of the 2008 financial crisis.
Despite the decisively tightening monetary policy in major economies, both OPEC and the International Energy Agency (IEA) continue to see global oil demand growing annually both in 2022 and 2023. Despite the deteriorating economic environment and concerns over Chinese demand due to COVID lockdowns, the IEA expects world oil demand to grow by 2 million bpd in 2022 and by another 2.1 million bpd next year. OPEC, for its part, still sees global economic growth staying robust at 3.1% this year and another 3.1% next year in its latest forecast, suggesting that the cartel still expects healthy oil demand growth despite market fears of recession.
Moreover, analysts and forecasters say that gas to oil switching this winter and tight product markets—especially diesel in Europe—could also support oil demand even in a mildly recessionary environment.
Then there is the expected supply shock from Russian exports and the still unclear mechanism under which the West is seeking to keep Russian oil flowing by applying a price cap on Russian oil, which Putin may simply refuse to sell as he has already threatened.
A global recession would normally rebuild inventories and capacity buffers. But with the war in Ukraine, which Russia, the world’s second-largest crude oil exporter, has just escalated with the mobilization of 300,000 men, all bets are off.
