The Russia-Ukraine conflict has been putting upward pressure on global energy markets. However, the gains have been kept somewhat in check by COVID-19 lockdowns in China. Kim Parlee speaks with Daniel Ghali, Director, Commodity Strategy, TD Securities, about why that may be about to change.
- We've all been watching the energy markets rocket up, oil getting up to and then backing up to our 100, but our next guest says, stay tuned. He thinks there's another breakout that could be coming. We could be seeing more upside in oil prices. Daniel Ghali is Director of Commodity Strategy at TD Securities. He joins us now. Daniel, it's great to have you with us. I think a lot of ears just perked up when I said what you think is coming. Let's talk a bit about some of the mechanics before we get to your out look. This has a lot to do with the COVID lockdowns that have been happening in China, which you believe in putting a ceiling on the price of oil. Maybe just take us through that, and you see that first off.
- Yeah, absolutely, and thanks again for having me. So I'd say that energy markets are coiling toward the breakout here, and the reason we use the term coiling is because they're currently under immense pressure from the massive scale of the lockdowns in China, but also from the massive scale of the release of oil reserves in the United States and by the IEA. So amidst these tremendous pressures on oil prices, we're still seeing them remain resilient above $100 a barrel. And mind you, these forces are really transient in nature, so that begs the question, what will happen when these transit forces dissipate? So let's begin.
- All right.
- I'd say on the demand side of the equation, we mentioned the lockdowns in China as one of the primary forces weighing on oil prices at the moment, mind you that they're still quite elevated. So when we're looking at the scale of disruptions that we're dealing with the war in Ukraine has catalyzed up to three million barrels a day of disruptions in oil supply, while the lockdown in China offsets about a third of that or half of that on its own at the moment, according to our estimates. And despite that, oil prices have remained resilient and I think one underappreciated reason why that's the case is that we're also currently going through a period of epic stockpiling across the world. A lot of people have talked about on-shoring as a way to shore up supply chains, but I think what's really happening here is that firms and nations have decided to increase their inventories of raw materials and of products in general as a method to shore up their supply chain and strengthen its resilience. The second part of the equation here, Kim, is on the supply side. We mentioned the massive scale of the SPR release, primarily by the United States, but really all we're doing here is borrowing from the future. By October, the level of the SPR reserves in the United States is going to reach its lowest level since the 1980s. So really what we're dealing with here are transient forces that aren't really targeting the structural problems at hand here in our energy infrastructure, and once they dissipate that can be the other side of the coiling process, and we could see an explosion towards higher levels here.
- All right. Well, let's talk a bit about, I mean, there's a lot of crosscurrents there. You outline them nicely. Let's say, the temporary-ness-- I'm making up words here-- dissipates, to your point, so Shanghai's back online and things start to come back. Where do you see oil prices going, and we've got about a couple of minutes here, Daniel.
- Right. Absolutely. So in terms of where oil prices might go, I think we're currently in a situation where really not many things have to go wrong for oil prices to trade at $150 a barrel or even higher. And the reason I'm saying that is that the oil energy intensity of the global economy has been declining through time. So the current levels that we're dealing with really aren't unprecedented in nature, and in fact, it's probably going to take a larger explosion to the upside before we really see demand destruction at a meaningful scale. And I've spoken about demand destruction here because I think that's really the only way that energy markets are going to find balance, and this is true for commodity markets broadly. We actually are in a situation where, after a decade of under-investment-- this is a structural supply story-- we currently don't have means to pick up supply at a quick pace and offset demand. So really, what has to happen, is demand has to come down for markets to find balance. A lot of people think we're staring down the barrel of a global recession as a result of the rise in commodity prices, but I think that commodity prices will have to rise even further than they have historically in order for us to catalyze anything like that.
- Daniel, I've only got 30 seconds, but so bear with me for a second. Oil prices get up to $150. I know the problem-- there's been an under-investment in getting oil out of the ground, but you could see maybe US shale producers perk up. Maybe OPEC perks up. Is it really that constrained that they can't get more oil on the market more quickly when it gets to that level?
- Well, absolutely. I think OPEC has been persistently under producing relative to their quotas, and that reason is that there's operational risks that are a result of a decade of under-investment. When we look at the US shale patch, that's really a question of this term capital discipline here, and what that term is really referring to is that, after a decade of delivering sub-par returns for investors, the incentives aren't there for producers to reinvest capital into their operations, and instead, investors are demanding for them to redistribute that cash. So I think here the incentives aren't right in the US. OPEC is struggling with persistent structural supply story here, and that's a macroeconomic story that's going to lead to higher energy market prices.
- It's interesting times, Daniel. It's a great analysis. We appreciate your time. Thank you so much.
- Well, thank you very much, Kim. I appreciate it.