Oil heads for uncharted territory in 2022 amid volatility and Opec's output decision

The threat of Omicron loses steam with demand steady, but key oil-consuming countries look to play a more active role to tackle inflation stoked by higher oil prices

Oil storage tanks at the GS Caltexoil terminal in Incheon, South Korea. The US will release 50 million barrels of crude from its strategic reserves in concert with China, Japan, India, South Korea and the UK - an unprecedented, coordinated attempt by the world’s largest oil consumers to tame prices. BloombergShow less

Oil prices are headed for uncharted territory in 2022, driven by Omicron-related uncertainties and bouts of price volatility. Opec+ is entering a new phase of supply recalibrations and the US and key oil-consuming countries are looking to play a more active role in the markets.

Oil prices, which surged more than 60 per cent last month to trade above $80 per barrel, supported by gradual economic recovery in key markets, fell below $70 per barrel as the rapid spread of the more infectious Omicorn variant of the coronavirus raised question about the pace of economic momentum in the future.

But crude prices have clawed back some of the lost ground in recent weeks. Brent, the international benchmark under which two-thirds of the world's crude is traded, was up 0.3 per cent to $79.18 per barrel at 11.46am on Wednesday. West Texas Intermediate, which tracks US crude grades, was 0.2 per cent higher at $76.13 per barrel.

Crude prices have more or less hovered above $70 per barrel and made an incremental climb after the Opec and its allies decided to bring 400,000 barrels per day of crude to the market in January despite the release of Strategic Petroleum Reserves by the US and other countries.

Market analysts had widely expected Opec+ to pause production increases in January, given the Omicron-driven uncertainties. However, despite staying the course and increasing output, Opec+ said it could review its policy at a short notice if the rising number of coronavirus infections, spurred by the Omicron variant, chokes off demand.

Omicron is now the dominant coronavirus variant in major economies including the US, the UK and some parts of Europe. Travel restriction on some African countries did little to check its spread and some European nations, including the UK, are now considering bringing back stricter restrictions to control the pandemic and protect healthcare system from being overwhelmed.

There are dire warnings from the World Health Organisation, which told Europe to brace for a punishing wave of Omicron cases over the winter as “we can see another storm coming”. India is expected to see a short but severe surge in the number of Covid-19 infections.

While some traders and analysts fear the widespread travel restrictions could have an impact on economic momentum and weigh on oil demand, Opec earlier this month raised its global oil demand forecast for the first quarter of 2022. However, the oil producers' group has left its full-year growth estimate unchanged.

Opec and its allies are meeting on January 4 to decide whether to bring more supply to the market. Reuters

The impact of Omicron is projected to “be mild and short-lived, as the world becomes better equipped to manage Covid-19 and its related challenges”, it said at the time.

Opec expects oil demand to average 99.13 million barrels per day (bpd) in the first quarter of 2022, up 1.11 million bpd from its forecast last month, according to its monthly bulletin. World oil demand growth was kept unchanged at 4.2 million bpd and total global consumption at 100.6 million bpd.

“The Opec+ meeting remains in session, giving the group the opportunity to immediately react if news suggests that the Omicron variant might impact oil demand. This is, in our view, an important guidance element, which should help reduce the downside risks for oil prices in the near term,” according to Giovanni Staunovo, commodity strategist at UBS.

“We still expect oil demand to reach record highs next year, which should support prices.”

The Swiss lender expects Brent to rise again to $85 per barrel in 2022, however, several countries “erring on the side of caution and restricting international travel”, could slow the oil demand recovery.

“However, we continue to see value in longer-dated oil contracts for risk-seeking investors,” Mr Staunovo said.

Although parts of Europe have turned to stricter measures to curb mobility to bring the Omicron spread under control, the variant has yet to dampen road traffic across most of Asia, suggesting energy demand in the region may be spared a significant hit.

More cars have crowded main roads in December than last month, amid end-of-year festivities. All but one major Asian country registered a rise in mobility month-on-month, according to data compiled by Bloomberg using Apple's mobility statistics until December 27.

Analysts including Ehsan Khoman, director of emerging markets research, EMEA at MUFG Bank also expect demand to remain robust and prices to remain higher despite Omicron uncertainties.

“As economies reopen with individuals learning to live and embrace with an endemic Covid-19, the interaction of wealth accumulation, pent-up demand, pro-growth fiscal policies, still accommodative monetary stances from major developed market central banks, alongside progression on vaccination campaigns progressing and increasing mobility, will keep the underlying oil demand recovery robust in 2022,” Mr Khoman said in a research note.

MUFG foresees a market deficit allowing for higher commodity prices next year.

“With the oil market remaining balanced on an annualised basis in 2022, low overall stock levels should keep prices firm, with our modelling estimates pointing to Brent and WTI crude averaging $75 per barrel and $72 per barrel, respectively, in 2022,” Mr Khoman said.

The problem of underinvestment in oil infrastructure during the pandemic, declining inventories and the drive for energy transition could push the oil market to return to a structural deficit by 2023 and “new structural bull oil market” may emerge, according to MUFG.

Global investment bank JP Morgan last month said that underinvestment in the sector over the past 18 months caused by the pandemic has hit the output capacity of many producer countries and their ability to respond to recovering oil demand.

It predicted Brent would “overshoot” $125 a barrel next year and $150 in 2023 due to lack of adequate investment in the sector.

Investment in the hydrocarbons sector dropped amid green transition efforts and changing government regulations, a report by the International Energy Forum and IHS Markit said earlier this month. Total investment in the upstream sector of the oil and gas sector fell 23 per cent below pre-pandemic levels to $341bn in 2021 despite a rise in oil demand globally, the report said.

The global oil and gas industry requires more than $600bn of investment annually until 2030 to keep pace with the rising demand, Dr Sultan Al Jaber, UAE Minister of Industry and Advanced Technology and managing director and group chief executive of Adnoc, told the Abu Dhabi International Petroleum Exhibition and Conference last month.

Echoing his views, Suhail Al Mazrouei, Minister of Energy and Infrastructure, also said a lack of investment in securing future energy supplies could extend the cycle of higher oil prices.

“If we are not investing enough, I am afraid, we could see highs like we have seen in coal and in gas due to lack of investments,” Mr Al Mazrouei said at the time.

He credited the Opec+ bloc of oil exporters, of which the UAE is a part, for helping to stabilise oil prices.

“While the demand side of the oil equation received most of the attention in 2021, given the pandemic and the vaccine-led recovery, we believe that more critical for 2022 is the outlook for supply, especially surrounding the call on Opec+, which remains challenged, at best,” Mr Khoman said.

The Opec+ group of oil producers, headed by Saudi Arabia and Russia, is meeting on January 4 to decide if it will stay the course and go ahead with a planned production increase of 400,000 barrels per day in February despite the threat of Omicron.

“The most important event for oil markets is going to be Oec+’s meeting,” Naeem Aslam, chief market analyst at Ava Trade, said.

Emirates NBD, the biggest lender in Dubai, said by taking a “flexible and responsive approach” in its December meeting, Opec+ producers “could help to set a floor under any collapse by cutting production” should Omicron prove to be a far more serious threat to public health, which could result in a considerable downside risks to oil prices.

Opec+ this year has pushed back against pressure from the US, the world's largest producer of crude, and key importing nations such as India and China to bring additional supplies to the market.

Higher oil prices have caused rising inflation in several parts of the world, with an increase in petrol prices becoming a particularly sticking point as the US heads to mid-term polls.

In November, the US said it would release 50 million barrels from its strategic reserves — stocks of crude maintained to meet emergency needs — to subdue prices. The US intends to bring forward a planned sale of 18 million barrels of crude and will exchange the remainder with buyers in an oil market repo.

India, which has been at the forefront of lobbying to bring oil prices down, will make a smaller commitment and release 5 million barrels. Japan will also bring 5 million barrels to the market, while South Korea will add 3.5 million barrels.

Japan is planning the release of 100,000 kilolitre crude sale from its strategic reserves, a trade ministry official said last week.

China has yet to announce a number, but the world's biggest importer of crude is likely to release between 7 million and 15 million barrels. The UK, which is also backing the US initiative, will add a nominal amount of 1.5 million barrels.

“Mid-term elections in the US next year might result in renewed actions if gasoline prices stay elevated, I guess. But on the other hand, if Opec+ spare capacity is at low levels next year as we expect and demand keeps recovering, asking Opec+ to pump even more would not help either,” said Mr Giovanni of UBS.