Will Oil Prices Stay High? 2024 Could See a Collapse of Demand. – Barron’s

Current oil-market crises started with excessive European Union government policies. Germany shut down its nuclear plants, leaving it highly dependent on Russian gas. That empowered Russia’s invasion of Ukraine. However, rather than a blitzkrieg to Kiev, the Ukraine invasion became a quagmire. Russian gas and oil were cut off from Europe, driving a recession in—you guessed it—Germany. Massive beneficiary: the U.S., which has become the world’s largest liquid-natural-gas exporter, from zero in 2016.

In response to high prices, in 2022 the Biden administration released a vast quantity of oil from the Strategic Petroleum Reserve. But at the time China was pursuing a zero-Covid policy that muted oil demand in the world’s biggest oil importer. Some of the SPR release was, ironically, sold directly to China, which took advantage of lower prices to build inventory.

The knock-on nuclear shutdown effect, combined with poor French nuke performance, was to drive massive increased coal use in Germany, contributing to world coal demand and prices hitting all-time highs. German coal is poor-quality lignite, with the highest CO2 emissions of any major primary energy source. At times in 2022, export coal grades traded above low-sulphur diesel on an energy-equivalency basis, a complete inversion of the natural energy price order.

Late last year OPEC+, a group made up of the original cartel plus Russia and others, announced a two-million-barrel-a-day production cut. But those cuts never materialized into lower exports; China’s demand recovered less aggressively than expected, and Russian sanctions impacted exports less than feared. India and China gobbled up the cheap Urals crude for their massive new refineries—and exported the oil products, including to the U.S.

Suddenly in 2023, even as China demand recovered, the oil market was under downward pressure. Saudi Arabia made cuts to production and export midyear with Russian vocal support. Those cuts have served not only to reduce global crude supply by more than a million barrels a day but also tighten the market for the heavier, sourer crude grades favored by the biggest, most complex refiners to make distillate, tightening the global diesel balance. This month Russia announced a diesel export ban in an already-tight market. Note that as refiners push to produce diesel, they produce excess gasoline. U.S. pump prices may have peaked, barring events like a major U.S. refining accident.

The midyear Saudi cut was initially bullish for oil stocks, but that effect is fading. Wall Street naturally sees Saudi cuts as actually bearish, because they speak to weak demand, which will be further weakened by higher prices.

Twice in the past decade, when faced with unilaterally cutting production to maintain oil prices, Saudi Arabia has increased oil production to assert market dominance. In 2014 Riyadh was faced with booming U.S. oil production growth and Iran emerging from sanctions. Facing the direct loss of market share to Iran, the Saudis would not cut production unilaterally and walked out of the Thanksgiving 2014 OPEC meeting. That market-share war drove oil prices down to just $27 a barrel in 2016. Again in 2020, confronted by a Covid demand collapse, Saudi increased production to a record high in a market-share war with Russia. That episode proved Saudi Arabia could surge production up to 11.6 million barrels a day. It is now just 9 million.

In principle, the oil cycle is: Prices rise, companies invest in more supply, then demand weakens, and prices fall. But that is completely distorted by heavy-handed politically driven government action. (We haven’t even discussed the Federal Reserve, which created inflation through money printing. It’s now powerless over oil, unless it crushes demand, which means crushing the economy.)

Oil equity investors are now fearful of a nightmarish combination of a Fed-induced U.S. recession, adding to European recession, and a China with major economic issues. That spells weak 2024 demand. At the same time, non-OPEC supply growth is expected to be robust in 2024. And Saudi Arabia has two million barrels a day of spare capacity. As long as oil prices are in the $100 range, the Saudi strategy is clearly working. But a sustained combination of weak global demand and robust non-OPEC supply growth could lead us into another global oil market share war, and much lower prices.

Regardless of the potential for 2024 oil weakness, if you believe the global energy system is underinvested, you should buy the bottlenecks. Energy stocks are cheap relative to the market and highly cash-generative, with almost universal high cash-return-to-shareholder strategies. While the volatility of government policies is so damaging, highly constrained growth spending and excellent cash returns are likely. But multiple expansion into this uncertainty? Forget it.

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