By Malcolm Melville
After a surge in oil prices during 2021, market attention is now turning to 2022. Inventories will likely start the year below the five-year average, and natural gas prices in Europe and Asia significantly above long-term norms.
Unless Iranian oil production picks up meaningfully or Covid-related travel restrictions disrupt demand, oil inventories will remain low, and prices could breach US$100/bbl in 2022. Indeed, if OPEC members continue to struggle to meet production targets, much more bullish scenarios are plausible for crude markets.
Demand set to grow in 2022
We expect oil demand to grow to 100.23 million barrels per day (mb/d) in 2022, up 3.5mb/d from 2021 and comfortably above the 2019 levels of 98.27mb/d. This is based on forecasts for global GDP growth.
Additional demand for oil will come because of switching from gas to oil. The estimates for this range from 0.2mb/d to 1mb/d from Europe and Asia where the price of gas is high enough to provide an incentive for switching.
Gas prices would need to double in the US for switching to be worthwhile, so we don’t anticipate any additional oil demand in the US from switching.
An additional source of demand could come from a rise in airborne freight, given the current problems with global supply chains. However, this is difficult to forecast and therefore is not included in our demand assumptions.
Supply will remain limited
If our demand assumptions prove correct, an additional 3.5mb/d of supply will be needed in 2022 at the very least. This supply is likely to come from OPEC, Russia, and the US, with OPEC having the largest potential.
After cutting production by around 10mb/d in 2020 following a collapse in demand due to the Covid-19 crisis, OPEC+ (which includes 10 additional countries, including Russia, Oman, and Mexico) is now increasing output by 0.40mb/d per month until September 2022 when each country hits their baseline.
If OPEC production doesn’t return to the baseline numbers, but instead can only return to the average production levels before Covid-19, then output will only increase by 1.2mb/d. This would be some 2.3mb/d short of the required new supply and could lead to higher prices for crude oil.
In the US, pre-Covid-19 production peaked at 13mb/d and is now at 11.3mb/d. The lack of investment over the past few years, due to significant capital restraint (as investors demand improved returns to shareholders and climate change considerations come to the fore) means that production is likely to increase by around 1mb/d to 12.3mb/d.
What are the main risks facing the oil industry in 2022?
There are three main risks to oil demand in 2022. These are: 1) if there is a return to widespread mobility restrictions if Covid-19 disrupts travel again; 2) a fall in demand from a short-term price spike; and 3) a weakening of growth due to supply chain disruption.
The biggest risk in terms of supply comes from Iran, which could increase production by around 2mb/d if relations with the West improve markedly. The exact pace and quantity of this is unknown. However, given the magnitude of the potential increase and the current market assumption that limited Iranian supply is likely in 2022, the impact on price could be significant. The increased Iranian supply would swing the balances for 2022 into a meaningful surplus.
The US has limited options on supply, but the most effective would be a change in its energy policy to encourage more oil production in the US. However, following the recent COP26 event this would seem unlikely.
Malcolm Melville is the Energy Fund Manager at Schroders