Why oil consumers are bracing for a summer of pain

Underinvestment in energy and a downward trend in refining capacity have been contributors to the fuel shortage

The Ruhr oil refinery operated by BP Gelsenkirchen, a subsidiary of BP, in Germany. Some of the market’s top policy figures agree that the world does not currently have enough refining capacity. BloombergShow less

Oil bulls are starting to picture a world in which China, the engine of demand growth, comes back to the market.

And if their analysis is right, the summer is going to be painful for oil consumers everywhere who’re already facing spiralling prices — whether that’s Americans paying about $5 a gallon for petrol, or the British spending more than £100 ($125) to fill a regular car.

In China, renewed restrictions in Shanghai point to a bumpy path ahead, but the world’s biggest crude importer is tentatively emerging from its latest battle with the coronavirus. That is set to add consumption to a market that has traded around $120 a barrel for its longest period in years with little help from China.

“I’ve never seen this combination of circumstances in my career over the last 50 years,” said Gary Ross, an oil consultant turned hedge fund manager at Black Gold Investors.

“The world has very little spare capacity, the economy is strong outside of China, China is now coming back and we’re in the midst of a global oil interruption.”

Opec+ officials said this week there is little extra supply they can add, while similar constraints within the global fleet of oil refineries has consumers facing fuel prices that are rising faster than crude.

Several countries have announced embargoes on Russia, one of the world’s largest producers, following its military invasion of Ukraine. That is disrupting available supplies of crude and fuels. Consumption of refined products has been outpacing production, further eroding inventories.

Much of Wall Street shares the bullish take. This week, Goldman Sachs Group said it expects Brent to peak at $140 a barrel in the coming months. Morgan Stanley said its most bullish scenario of $150 could be moved higher. The record for Brent is $147.50, set in July 2008.

China National Petroleum estimates the country’s consumption could jump by 12 per cent in the third quarter. Bank of China International said it expects a modest recovery in the third quarter, and a stronger fourth.

“We are at $120 without China, so when China comes back, oil is going to go higher,” Amrita Sen, chief oil analyst at consultant Energy Aspects, said at a conference in Calgary.

“Even with high prices, demand is continuing because people, they want to travel, they want to get out. And the second thing is that governments around the world are subsidising prices.”

Those subsidies — or reduced taxation — are boosting demand in countries from Mexico to South Africa. That is one reason why oil prices have held up despite US gasoline futures already trading close to $180 a barrel.

Russia is a major supplier of refined products, most notably diesel, where wholesale prices in Europe are around $170. The premium of both diesel and gasoline over crude has hit a record this year in the US and Europe, with fuel stockpiles low going into summer.

Some of the market’s leading policy figures agree that the world does not currently have enough refining capacity.

Amos Hochstein, the US State Department’s senior adviser for energy security, told an RBC Capital Markets conference this week that underinvestment in the energy space and a downwards trend in refining capacity have been key contributors to the shortage of fuels, echoing a view held by Saudi Arabia’s energy minister.

The US government has even asked the refining industry about firing up mothballed plants again.

What all this means is that, despite the Organisation of Petroleum Exporting Countries and its allies pledging to increase output by more than expected this month, there is little sign for now that such moves — if they do happen — would derail the rampantly bullish market.

Opec secretary general Mohammad Barkindo said this week only two or three of the group’s members have room to increase output.

Even with some parts of Shanghai heading back into Covid-19 restriction, traders believe that an eventual pickup in consumption will come in an oil market where production is, for now, largely tapped out.

For consumers, that is especially risky before summer, when refined product consumption rises thanks to travel and air conditioning demand.