We seem to be right: The explosive spread of omicron does not correspond with a change in the number of hospitalizations, which is usually considered as a more relevant number to decide to put lockdowns in place or travel bans. In the longer term, this dynamic could also be bullish for demand, as it leads to more natural immunization and higher vaccination.
While the final impact of omicron is still uncertain, we are raising our demand forecast for 2022 modestly due to the low probability of a reduction in oil demand from omicron and the strong 2021 year-end demand print. Supply, meanwhile, continues to be constrained as OPEC under delivers on stated targets and US producers maintain capital discipline promises. Thus, 2022 supply/demand stays balanced, supporting prices around current levels, in our view. Attention will likely soon turn to 2023 and the possibility of Iranian volumes returning could tip the global market into oversupply and weigh on oil prices. However, depressed prices (US$60/barrel) are already factored into our fair value estimates.
Global crude overview
Initial fears have been eased with the new data that suggest the omicron strain has mild effects. Although highly transmissible, the variant said, vaccines are still successfully preventing severe illness and limiting death rates. But most economies are now transitioning to tending to infection rates instead of flatly avoiding them. Together with stronger than expected demand in Q421, we have decided to modestly lift our demand expectation.
China does pose a risk to our demand outlook if it continues to follow its strict zero-COVID strategy, especially considering the high transmissibility of omicron and the lower efficacy of Chinese vaccines. With food shortages and lockdown fatigue gripping major cities throughout mainland China, the government has so far shown little inclination to change course. An increase in infections by mid-2022 cannot change demand elsewhere, because economies will keep reopening and return-to-office plans will gradually be put into place, even though international air travel will likely lag behind recovery. We raise our global consumption forecast for 2022 slightly, to 100.6 million barrels a day from 100.4 million b/d, but leave our 2023 forecast for 101.7 million mb/d unchanged, both of which supersede pre-pandemic consumption of 100.2 million mb/d.
OPEC maintained its existing output policy in January even as it repeatedly failed to meet its target quotas during the back half of 2021. The cartel has no reason to alter course and is likely to proceed with a steady ramp-up. Likewise, shale producers are aiming for low-single-digit production growth in 2022, and are unlikely to crank up output until OPEC is operating near full capacity. Thus, we have lowered our global supply forecast to 100.5 mmb/d and 102.6 mmb/d in 2022 and 2023 respectively (previously 101.5 mmb/d and 102.7 mmb/d). Oil prices could stay high until at least the first half of 2022 because the market remains tight. We do believe supply will catch up to demand around mid-2022 or by the end of 2022 at the latest which would suppress oil prices as a surplus of supply occurs.
OPEC dismisses concerns over Omicron, sticks to plan to increase output
For the seventh month in a row, OPEC and its allies confirmed at the cartel’s Jan. 4 meeting to remain on course to gradually boost monthly production by 400 thousand barrels a day. While the decision showed an expectation that the impact of the new variant on oil demand would fall short of initial expectations, actual volumes have continued to lag behind proposed monthly output increases. The cartel added just 283 mb/d of oil in November production, leaving a supply deficit of more than 500 mb/d.
Given that OPEC chronically underdelivered for most of 2021 and has little hope of catching up, we’ve cut our aggregate 2022 supply forecast for the cartel. The wild card is Iran; we still believe it is likely that the Biden and Raisi administrations find a common path to understanding in the interim but we don’t have the luxury of charging in that direction as we lack the foresight necessary to shepherd our reset (which doesn’t include returns for another 1.5 mmb/d of Iranian oil exports until mid-2023).
Shale Firms NOT Going to Accelerate much in 2022
Most US exploration and production companies will report their 2022 capital budgets in early February, with fourth-quarter results. We expect that few will break from the industry’s uniform messaging through 2021. Capital discipline stays priority number one, and management teams will focus on reducing reinvestment rates and maximizing free cash flows. The windfall from higher commodity prices will go as it always does: being used to patch up balance sheets, if needed, but otherwise being returned to shareholders through some combination of buybacks, special dividends, ratcheted base dividends or commodity-based variable dividends. As financial leverage has already fallen off a cliff after a decade of above-mid cycle prices (our thought global mid-cycle price for WTI crude remains at US$55/barrel), we'll see a greater proportion of companies in the latter category in 2022.
That is not a lot of space for boom time US. With about 500 rigs already in US oil plays, more would penalize supply and make it impossible to meet the likely call on the United States in the coming several years, assuming that Iran sanctions are not lifted for the foreseeable future. And if Iran sanctions are then lifted, the goldilocks level for US producers would drop to 400 rigs. Our 2022 forecast for the US. In oil plays, this supports an average of 500 rigs which translates an oil supply of 18.1 mmb/d, or 11% youp
