Commodities

Oil is the commodity in focus right now

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Oil prices started falling on June 3 after the OPEC+ conference, where the eight member countries agreed to extend cuts into 2025.Jeff McIntosh/The Canadian Press

Introduction:

The price of West Texas Intermediate (WTI) oil fell from a recent high of US$86.91 a barrel in early April to where it currently sits at around US$76. Closer to home, Western Canadian Select (WCS) has dropped from a high of US$72.99 in early April and now sits at about US$62. What is behind this price drop and what is the outlook for the commodity?

OPEC+ comments in a time of recession fears:

Oil prices started falling on June 3 after the OPEC+ conference, where the eight member countries agreed to extend cuts into 2025. At the same time, they opened the door for production increases starting in October by phasing out the voluntary cuts to which producers have largely been adhering. The increases will see an OPEC+ target of 36.27 million barrels a day (b/d), rising by more than two million b/d from current output. The UAE was also given a higher quota target of up to 300,000 b/d once the OPEC+ changes are fully implemented. These combined announcements drove the price of WTI down to US$73.25 last week. On Thursday, Saudi Arabia and Russia indicated they could maintain or reverse output depending on prevailing conditions, causing prices to turn up again. In conjunction with this, a strong U.S. jobs data report on Friday firmed up the U.S. dollar on the expectation rate cuts would be pushed out further.

How important is this to our energy companies’ stock prices? I ran a regression for the TSX Energy Capped Index against the price of West Texas Intermediate for the past seven years (starting three years prior to COVID, to understand transition through that period) and found a correlation co-efficient of 0.8, implying 80 per cent of the movement in that index is explained by movement in the price of WTI.

Over that time period the price of WTI has been between US$4.34 and US$45.93 higher than the price of WCS. The average spread between WTI and WCS for the past five years is US$15.85 a barrel. Both transportation costs and grade (light oil is easier to refine) account for the majority of the price difference. According to Deloitte, prices for Canadian producers are expected to rise with the completion of the Trans Mountain Expansion pipeline project.

Oil consumption – a quick background:

Two-thirds (67 per cent) of global oil production is consumed in transportation with another 27 per cent used for industrial heat or power generation. The balance is used in residential or commercial heating. Gasoline accounts for 41 of the 67 per cent, distillates (diesel fuel and heating oil) 15 per cent, jet fuel 8 per cent, and asphalts, lubricants and petrochemicals 3 per cent.

From their most recent figures in May, the International Energy Agency (IEA) shows global oil demand is set to rise by 1.1 million b/d in 2024. The outlook for 2025 is expected to be 1.2 million b/d higher than 2024.

World oil supply is projected by the IEA to increase by 580,000 b/d in 2024 to a record 102.7 million b/d as non-OPEC+ output rises by 1.4 million b/d while OPEC+ production falls 840,000 b/d, assuming that voluntary cuts are maintained. Gains of 1.8 million b/d are expected in 2025 as non-OPEC+ adds a further 1.4 million b/d.

What about the switch to EVs?

Gasoline vehicles account for 41 per cent of global oil consumption. The IEA expects to see 17 million electric vehicles sold in 2024 or 20 per cent of total car sales for the year. Sales in the first quarter of 2024 were up 25 per cent from the same period a year ago. With a projected switch of four million vehicles from gasoline to electric in 2024, the demand for gasoline should drop 1.9 billion U.S. gallons or 45 million barrels of oil equivalent a year. However, that compares with oil production of 100 million barrels daily, so it is a small – yet growing – change in demand.

Oil target prices

Oil prices are projected to move up over the summer months with more transportation activity and seasonal drawdowns of supply. Looking further out, according to information provided on the RigZone website, over the next two to three years there are mixed views on the price of oil, with some such as oil and gas research company BMI, Bloomberg consensus, the U.S. Energy Information Administration and J.P. Morgan seeing oil prices dropping, whereas others, including Standard Chartered Bank, have higher target prices. The current consensus seems to indicate oil prices will be moving down to the low US$70 level by 2026.

More about the author

Brian Donovan, CBV, is the president of a Canadian fintech based in Miramichi, N.B.

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