By Rick A. Veitch
Near-term hydrocarbon markets remain tight, stemming from Russia/Ukraine, but long-term oil prices are being driven lower by additional emerging factors.
Global hydrocarbon markets continue to take their cues from headlines out of the Russia/Ukraine conflict and related European gas shortage, but additional factors are increasingly shaping near-term and long-term crude oil and natural gas price expectations.
Recessionary fears in the U.S. and Europe, continued COVID disruptions impacting Chinese demand, and Russian barrels reaching the market have introduced bearish concerns into oil markets.
However, while prompt oil prices have declined below $100 over the past couple of months, we continue to see forward supply deficits in global markets, with additional demand destruction likely still needed.
Adjusting for the year-to-date appreciation of the U.S. dollar, forward refined product prices remain elevated in local markets and reflect prices at which we would expect demand destruction to occur.
Long-term oil prices have seen a meaningful decline over the past month. Forward markets now reflect $55-60 WTI, which is in the context of levels prior to the Russia/Ukraine conflict.
We attribute the downward move in long-term expectations to the strengthening U.S. dollar, which should create incremental broad-based headwinds to global demand, as well as the expected acceleration in the cost competitiveness of electric vehicles due to recent and future legislation.
Global natural gas markets remain rightly focused on the European gas shortage. Waterborne liquefied natural gas (LNG) remains the most expensive hydrocarbon on an energy-content basis. U.S. natural gas remains the lowest-cost hydrocarbon, which has driven significant international price arbitrage.
While U.S. upstream gas producers are unable to capture this difference today, it continues to drive a record pace of LNG export contract signings, which is likely to support future U.S. natural gas demand. Long-term U.S. gas price expectations have increased over the past several months, and are now in the $5-6 range (compared to $3-4 prior to the conflict).
Over the near term, elevated domestic U.S. natural gas prices remain driven by inventory levels. As measured by days of demand coverage, inventories remain well below historical levels.
Demand destruction pricing continues to be needed to improve inventory balances ahead of the winter heating season and into 2023. Domestic natural gas producers have either been logistically unable to respond to current prompt gas prices or unwilling to allocate capital.
With respect to U.S. energy issuers, we expect continued balance sheet improvement and stability from near-term oil and gas prices, with capital structures better positioned for future commodity downturns than in prior periods.
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