Kim Parlee speaks with Hussein Allidina, Head of Commodities at TD Asset Management, about why he thinks oil prices may be higher for longer amid constrained supply, even without the additional pressure from the Russia-Ukraine conflict.
- Well, as we've all been watching in horror what's been happening with Russia and Ukraine, the war continues, and we've seen volatility in markets and in oil prices. Here to tell us what he is watching and what he thinks is important is Hussein Allidina. He's head of commodities at TD Asset Management.
Hussein, it's always great to have you with us. I want to start with a look at the oil price over the last month, if we bring it up. It's been volatile. And I'm curious, how do you, as somebody who follows this, try and find some sense of equilibrium in the market? Is it even possible at times like this?
HUSSEIN ALLIDINA: I think it's super challenging, Kim. Thanks for having me. I think it's super challenging to figure out where prices are headed on a go-forward basis because we don't know, frankly, how much supply, ultimately, is going to be disrupted out of Russia. And we started 2020, 2021 with tight balances. And no one knows how much production is going to be lost.
Russia is not a trivial producer of oil and gas. It's hard. Inventories are still drawing. Kim, if you take a look at the daily data that came out earlier this week, balances are still drawing. It doesn't seem that demand has been rationed at these levels. So I don't think we're at equilibrium if we are going to lose incremental supply out of Russia.
- And it's tricky, too, I'm sure, because we're hearing, of course, that Canada, of course, has embargoed Russian oil. US close to doing that, it looks like. And then you also hear news of, perhaps, maybe Canada ramping up its oil into the market. So there's so many kind of puts back and forth to figure that out. There's a lot still coming.
- Yeah, look, I think the context, the size, the magnitude of Russia as it relates to oil, in particular, is meaningful. If you take a look at their crude and product exports, they're responsible for 7 to 8 million barrels a day of exports. And of course, a lot of that goes to Europe. The US, Canada take very little production from Russia. We don't have the spare capacity.
Kim, you and I have talked about this before, we don't have the spare capacity to replace Russia. And the logistics associated with replacing Russia are challenging, as well. If you're a Eastern European country that's got pipes supplying you, you're landlocked, you don't have too many choices.
- Yeah, and that's the problem, is this infrastructure, as we've heard on and on, takes decades, often, to build, to put in place. It's not something you turn quickly. I want to bring a chart up, Hussein, that you brought in. And I think you wanted to bring it in because it illustrates how tight the market is right now. Can you tell me what we're looking at and why it shows that?
HUSSEIN ALLIDINA: So I think you're looking at the chart that shows the curve, the degree of backwardation in the WTI forward curve today and over the course-- there's also curves from prior weeks, prior months. And the degree of backwardation you see there, or the willingness of the market to pay a material premium, a $10, $12, $15 premium for oil today versus oil for delivery a year from now, underscores the scarcity and how tight the underlying market is. The shape of that curve is highly correlated with the absolute degree level of inventory we have.
As inventories have been tightening and drawing, the backwardation has been more pronounced. And you know, this tells you in real time, I think, how tight the underlying market is, that refiners and consumers are willing to pay this material premium to have the molecule today vis-a-vis waiting till tomorrow.
KIM PARLEE: Can I ask-- I mean, a lot of what we've been talking about so far is the supply side. How are things looking on the demand side? I mean, with things kind of ramping up, quote, "back to normal" post-COVID, despite the fact we still have some lockdowns happening in China and other parts of the world, and are we going to see also just a dampened demand from the fact that just because oil prices are so high, you're seeing demand destruction, you're seeing inflation? Like, how does the demand picture look?
- Yeah, very good questions there, Kim. So I think a couple of points. One, we have to appreciate that, to your point, economies reopening, there is a bit of a tailwind to demand, absent what's happening in price. Secondly, seasonally, as we move into the second quarter and third quarter of the year, the summer driving season, you see a material increase seasonally in demand. So those forces are occurring notwithstanding the fact that prices at the pump are at nominal record highs.
I think we talked about this last time I was on, Kim. Prices in real terms need to still move to $200 a barrel if we're going to get back to the levels that we saw in 2008 when we saw demand destruction on a global basis. I'll tell you, I'm watching the high-frequency data. US gasoline data, demand data that comes out weekly is not showing any signs of demand destruction from price as yet. That and refining margins are two things to watch to see if the consumer is starting to buckle under the higher price. We haven't seen indication of that yet.
- Hm. I wonder if part of that is just people are just so eager and happy to be out and moving again maybe that they're willing to kind of pay that extra price to do it. We'll see over time if that plays in. Give me your sense, then, when you think maybe six months, two years, you know, what are you looking to see with oil prices then? What are-- yeah, give us some levels. What do you see?
- Yeah, so pre-Russian invasion of Ukraine, the view was that balances were poised to tighten because of a structural lack of investment over the course of the last 10 years through the bear market. That's true for oil. That's true for copper. That's true for nickel. And broadly speaking, it's true for all commodities.
Now, the challenge that the Russia-Ukraine situation presents is you have to ration demand in the short run in order to find equilibrium. And that might ultimately force prices to levels that really hurt global growth. So we could be in a position, Kim, where six months from now, because oil prices have gone to $150 or $200 a barrel to limit demand, we're in recession, and prices move back down to $70 or $80 a barrel.
Ultimately, when I'm thinking about kind of the medium term and thinking about the balance over the course of the next three to five years, I see prices having to continue to trade at elevated levels, north of $80 a barrel, north of $90 a barrel in order to ration demand because we still are not eliciting the supply response. And there is, obviously, an ESG and a sort of peak oil story associated with that, as well.
KIM PARLEE: It is a perfect storm of many factors. We're glad that you're here to explain it to us, Hussein. Thanks so much.
- Thanks for having me.