Oil price analysis and forecast｜4 reasons behind the fall

The price of Brent crude oil has fallen from US$125 per barrel in June and the market outlook has changed significantly. Low investment, low capacity, and low inventories have long been the main logic driving oil prices higher. The outbreak of the Russian-Ukrainian war in March exacerbated supply concerns and generated a significant crude oil risk premium. Coupled with the easing of covid-19 restrictions in Europe, the US and East Asian countries, strong oil demand and the market entering a peak season for refined oil consumption from May onwards, these factors combined to drive oil prices consistently higher. However, from mid-June onwards, these underlying factors supporting the rise in oil prices weakened significantly.?

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Firstly, the macro environment is deteriorating. Inflation is now a major problem for countries such as Europe and the US, and markets have long been trading recession expectations. Last week's 50 basis point hike in EU interest rates and the contraction in manufacturing activity in France and Germany in July, as well as a contraction in the German service sector and slower growth in the French service sector, are further indications that this top two Eurozone economies may be heading for a recession. Inflation in the US is also high, with the CPI rising to 9.1 in June, and with the Fed set to announce a new rate hike this week, it is a fact that the US is on the path of interest rate hikes, making it difficult for growth to meet expectations this year. This is accompanied by the risk of recession and therefore market demand for crude oil this year is not expected to be optimistic.

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Secondly, there has been a loosening of the supply side of crude oil. On the supply side, there have also been some new increments, driven by high oil prices: domestic capacity is slowly rising in the US, Canada and Brazil, production is recovering rapidly in Libya and is largely back to normal in Norway. However, it is a fact that global excess capacity remains insufficient and is now concentrated in the hands of OPEC countries such as Saudi Arabia, Iraq and the UAE, with the rest of the world operating at almost full capacity. Although production increases are being pushed forward in line with the 648,000 bpd plan, it will be difficult to reach the expected production levels. This is the core reason why oil prices are currently resilient.?

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Thirdly, the Russian-Ukrainian conflict had a smaller-than-expected impact on the supply side. Russian crude oil production in June was 9.39 million bpd, down 700,000 bpd from the previous month, but well below market expectations of a 2 million bpd cut. Export data showed that Russian crude oil exports increased rather than decreased, with 159.9 million barrels exported in May, an increase of 27.3 million barrels compared to the pre-conflict period. This is largely due to the significant discount on Russian oil, which has stimulated demand from Asia. So in the current environment, the Russia-Ukraine conflict has not led to a reduction in total global crude oil supply, but only to an imbalance in the structure of supply and demand in all regions of the world. The structural imbalance caused by the Russia-Ukraine conflict has also been somewhat mitigated by the EU's decision last week to extend the exemption for third-country oil shipments.

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Fourthly, the tight supply of foreign refined oil products has eased significantly. In terms of the current crude oil demand, the peak season for gasoline consumption has almost passed, with a buildup of gasoline stocks in the US and gasoline?pyrolysis prices falling from US$60/bbl to below US$30/bbl. Diesel pyrolysis prices have also fallen back to normal levels from US$58/barrel?to US$35/barrel. This suggests that the tight supply situation for gasoline and diesel does appear to be easing significantly.?

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Overall, the main logic of the current market trade remains a game between structural imbalances in supply and a significant contraction in demand. However, the overall pattern of tight supply and demand has now eased. Without new supply issues, crude oil prices may not reach above US$120 again this year but stabilized at US$90.?