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The Financial Post takes a look at some of the biggest issues Canadians have about business and investing in 2022 in our latest Burning Questions series.
Forecasting oil prices is a tough business at the best of times, but especially so when the COVID-19 pandemic continues to put consumer plans on hold, government policies are slowly dismantling the current global energy system and businesses are under a fog of uncertainty.
But one resistance level could offer a clue: US$72.4 per barrel. That’s the price Saudi Arabia needs to balance its budget in 2022, the International Monetary Fund estimates.
The Middle East kingdom has considerable influence over oil prices as the guiding spirit behind the 13-member Organization of the Petroleum Exporting Countries. Lately, Saudi Arabia and its allies have been in a power-sharing pact with Russia to stabilize the price of oil since its infamous plunge into negative territory in April 2020. The extended group, known as the OPEC+, has bandied together to drain excess inventories from the global energy system through quotas and curtailments.
Russia’s break-even price in 2021 was US$69 per barrel, so it’s likely domestic fiscal demands in both Riyadh and Moscow could determine the trajectory of global oil prices in 2022.
Ellen Wald, a fellow at the Canadian Global Affairs Institute and author of Saudi Inc., said breaking even is just one consideration for Saudi Arabia. The world’s largest oil exporter heavily relies on crude revenues to maintain its social contract with its citizens, but it’s not keen on jacking up prices to levels that will upset its Asian customers and fuel demand for alternative energy sources.
“They will be happy with oil prices in the US$65-to-US$75 range, even though (the lower end could be) technically below their break even,” Wall said in an interview, noting that state-owned Saudi Aramco’s oil production costs are among the world’s lowest.
Oil traders and analysts are looking through the tea leaves to ascertain whether the Saudi-Russian alliance will hold in 2022, and we could know as early as Jan. 4 when the extended group meets virtually.
“People have come to see the Saudi-Russia partnership as the norm for Russian behaviour, but it’s actually the exception,” Wald said. “(The Russians) have found co-operation to be quite valuable for them, but it is based on Russian interest.”
Russian President Vladimir Putin may not have the bandwidth to open a fight on another front anyway, given Moscow is fighting Europe on natural gas, and there are escalating tensions with the United States over Ukraine, especially as higher output could derail a carefully orchestrated rally.
Spare Capacity
Other producers are also wary of raising output, which has most major Wall Street and Bay Street analysts expecting Brent prices to average in the US$60-to-US$79 range by the end of 2022.
But JPMorgan Chase & Co. has an US$80 call, with the Wall Street bank expecting prices to briefly overshoot US$125 a barrel next year and US$150 in 2023 due to capacity-led shortfalls in OPEC+ output.
West Texas Intermediate price could average around the US$67 mark in 2022, according to median analyst forecasts collected by Bloomberg.
Conditions are ripe for Canadian producers — and their shareholders — to rake in the cash
Most Canadian oil producers would take those prices.
Calgary-based investment bank Peters & Co. estimates the Canadian oil sector is poised to hand out $32 billion in total shareholder payments in 2022 — an all-time record. Oil and gas producers could hand out $9.5 billion in dividends and $9.6 billion in buybacks, while infrastructure players such as Enbridge Inc. and TC Energy Corp. fork out a combined $12.9 billion in dividends and buybacks.
“Overall, the 2022 numbers could easily be higher than we present by the time the year is complete (particularly if companies get more aggressive on shareholder returns versus allocating capital to other areas like M&A),” the bank said in a note to clients in December.
Rory Johnston, managing director and market economist at Price Street Inc., said conditions are ripe for Canadian producers — and their shareholders — to rake in the cash.
“We are not going to see the gangbusters growth we expected to see historically from the Canadian patch, but it’s also not going to fall back either,” he said in December. “You combine those high production levels with a relatively weak Canadian dollar, so that’s going to boost their earnings, and relatively high oil prices and it’s really a cash-flow sweet spot for Canadian producers.”
The focus of Canadian producers and others on higher dividends and buybacks rather than output could light a fire under oil prices.
The International Energy Agency estimates Canada, the United States and Brazil will reach the upper limits of their production levels in 2022, which combined could add 1.4 million bpd to production — with the U.S. accounting for almost three-quarters of that increase.
“Saudi Arabia and Russia could also hit records if remaining OPEC+ cuts are fully unwound,” the IEA said in its December report.
That could theoretically add 6.4 million bpd of production to the market, which is unlikely if the Russian-Saudi pact remains intact.
OPEC+ is widely expected to keep a lid on output, which could be a recipe for a price spike, especially if COVID-19 and its variants dissipate in 2022.
“With little new capacity expected to come online inside and outside of OPEC in 2022, it is possible that global oil markets tighten significantly once consumption finally recovers from the pandemic,” Henning Gloystein, analyst at Eurasia Group, said in a note.
“Given that rising climate concerns are making it harder to find lenders for future oil projects, it is possible that a period of elevated oil prices follows the pandemic even amid a green transition, a development already seen in the coal sector (in 2021).”
One oil product to watch for is jet fuel. Other oil products have surpassed or are within a whisker of their pre-COVID levels, but jet fuel and kerosene demand hasn’t recovered, averaging around 5.17 million bpd in 2021 compared to 7.9 million bpd in 2019.
The IEA expects jet fuel demand to reach 6.2 million bpd in 2022, which is still way below its pre-pandemic levels, but a travel boom could alter the market dynamics.
Downside Risks
Wald believes higher labour and raw material costs could rein in producers’ exuberance, especially in the cost-conscious U.S. industry.
“Inflation is going to restrict some of the growth we could see in U.S. shale in 2022,” she said.
Soaring inflation rates could also crimp energy demand since many vulnerable emerging economies are still reeling from COVID-19. The U.S. Federal Reserve’s likely decision to raise interest rates to tame inflation would strengthen the U.S. dollar against emerging-market currencies, leaving them with lower purchasing power.
The return of Iranian oil in the event of a breakthrough with Western powers and the possibility of Western sanctions on Russia could also emerge as market spoilers, but a key wild card is the battered and bruised U.S. shale industry in 2022.
In years past, the free-wheeling, over-leveraged producers from North Dakota, Texas and Pennsylvania emerged as the world’s “swing producers,” pumping out record output every time prices threatened to break above the US$60-to-US$70 mark.
But the oil-price crash of 2020 has left the American industry severely damaged. The U.S. Department of Energy expects domestic oil production to average around 11.85 million bpd in 2022, below its peak of 12.29 million bpd in 2019.
U.S. producers are also intensely focused on dividends and stock buybacks rather than higher production.
“For 2022 as a whole, we expect that growth in production from OPEC+, of U.S. tight oil, and from other non-OPEC countries will outpace slowing growth in global oil consumption, especially in light of renewed concerns about COVID-19 variants,” the U.S. Department of Energy noted in its December report. “We expect Brent prices will remain near current levels in 2022, averaging US$70 per barrel.”
But Bob Brackett, an analyst at Sanford Bernstein & Co. LLC, believes U.S. shale producers could still wreck OPEC+’s well-laid plans.
“Should shale discipline collapse and the U.S. regain its role as marginal producer, commodity price could collapse to [around] $60 per barrel,” Brackett said in a note.
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