Running on empty: four themes dominating the energy market outlook

Global energy markets are at a crossroads. How will the supply-demand imbalance, economic growth concerns, and the war in Ukraine influence where they go next?

We see four major themes dominating global energy markets for the rest of this year. Here’s how we think they could affect the direction of global prices and supply.

Weaponisation of supply by Russia could be here to stay – and that’s a big risk, especially for Europe

The restart of the Nord Stream 1 gas pipeline in July provided only a temporary reprieve for European energy markets, and more recent developments reminded that the weaponisation of energy supplies by Russia remains a pressing risk, both for the region and for global growth.

Benchmark natural gas front futures prices are still below levels seen in the early stages of the war in Ukraine, but the futures curve shows that natural gas prices later in the year, including in the winter when seasonal demand is high, are much higher than at the early stages of the war. Those higher prices portend a difficult winter ahead.

To the extent possible, switching energy source from natural gas, as suggested by the EU plan to reduce natural gas use, could boost prices for alternatives including oil and coal. Oil prices are high but natural gas prices are extremely expensive relative to historical norms, much more so than oil.

Oil prices, while high, are still within the range of the past 20 years. Natural gas prices are abnormally high relative

Sources: Bloomberg, NatWest Markets

Fuel inventories are already too low, boosting European demand for US liquified natural gas

Russian supply is being phased out at a time when global stockpiles of energy product are already abnormally low. The embargo of Russian energy leaves higher demand chasing fewer sources of oil and gas, boosting prices.

Crude oil inventories across OECD nations are already at multi-year lows (see chart below) and may not recover to their pre-Covid norms until late 2023, according to the US Energy Information Administration (EIA).

OECD oil inventories vs. the 5-year average

Sources: US EIA, NatWest Markets

Natural gas inventories are also abnormally low. Gas markets are global, and European demand for US supplies to facilitate their transition away from Russian energy boosts demand for US LNG.

Don’t count on OPEC to rescue global energy markets

President Biden’s high-profile trip to the Middle East in mid-July, including his meeting with Saudi Crown Prince bin Salman, has increased market speculation that Saudi Arabia will heed US calls for faster oil supply increases. While some modest pick-up in quota increases is expected, don’t count on a change in OPEC strategy as a game changer for global oil markets.

OPEC+ has been steadily increasing oil output quotas from their pandemic-depressed levels, but their pace of production hikes has been conservative, methodical, and slow. Global concerns about demand may reinforce that conservative stance.

Additionally, the politics of OPEC are complex. OPEC has a formal oil alliance with Russia and other non-OPEC producers, a group referred to as OPEC+. Giving in to western demands risks alienating Russia, fracturing the long-term oil partnership between these two massive global producers.

Furthermore, OPEC spare capacity is estimated to have fallen, as illustrated below. Many OPEC+ members have struggled to actually increase production, despite their maximum quotas increasing each month. Like nearly everything else in the global economy, oil production is not immune to supply chain and labour disruptions. For these reasons, we don’t think OPEC is poised to dramatically improve the oil supply backdrop.

OPEC spare capacity and production (millions of barrels)

Sources: Bloomberg, NatWest Markets

Fears around future energy demand will continue to constrain investment

Consumers and businesses are increasingly pessimistic about the economic outlook, and investment intentions in business survey data have fallen to pandemic-era lows. Strong labour markets and pandemic-era government support left consumers in a strong position during the early phase of the recovery. But the surge in inflation, including higher energy prices, combined with tightening global financial conditions present risks to the outlook for consumption.

A thriftier global consumer and slower business investment may combine to dampen energy demand, and with it lower prices. These concerns have contributed to a recent dip across key commodity prices, including oil and copper, and have created a difficult situation whereby demand is very strong now but future demand is seen as much weaker.

We see lower investment intentions as a natural consequence of current demand fears; more oil supply is needed now, but investment decisions being made today are made with future demand, and prices, in mind. A surge in global oil production to meet today’s demand sits at odds with these fears about future demand. That could exacerbate the supply-demand imbalance for longer yet.

US Business Investment Intentions have fallen to Pandemic-era lows

Source: NFIB, Dallas Fed, Philly Fed, NatWest Markets

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This material is published by NatWest Group plc (“NatWest Group”), for information purposes only and should not be regarded as providing any specific advice. Recipients should make their own independent evaluation of this information and no action should be taken, solely relying on it. This material should not be reproduced or disclosed without our consent. It is not intended for distribution in any jurisdiction in which this would be prohibited. Whilst this information is believed to be reliable, it has not been independently verified by NatWest Group and NatWest Group makes no representation or warranty (express or implied) of any kind, as regards the accuracy or completeness of this information, nor does it accept any responsibility or liability for any loss or damage arising in any way from any use made of or reliance placed on, this information. Unless otherwise stated, any views, forecasts, or estimates are solely those of NatWest Group, as of this date and are subject to change without notice. Copyright © NatWest Group. All rights reserved.

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