Oil could trade near $100 this year. Here's what could drag prices back down.

By Myra P. Saefong

J.P. Morgan says demand destruction, SPR drawdown may 'mitigate' high oil prices

Russia's decision to deepen its oil production cuts could lift global benchmark crude prices near $100 a barrel by September, but demand destruction may play a part in dampening price prospects, analysts at J.P. Morgan wrote in research note dated Wednesday.

On March 3, several countries that are part of OPEC+ - which represents the Organization of the Petroleum Exporting Countries and its allies - extended additional voluntary output cuts of 2.2 million barrels a day to support the stability and balance of the oil market.

In a surprising move, however, Russia said it would voluntarily cut 471,000 barrels a day of crude-oil output and exports through the second quarter of this year. That is in addition to a voluntary reduction of 500,000 barrels per day Russia previously announced in April 2023, which extends through the end of December 2024.

"The shift in Russia's oil strategy is surprising," J.P. Morgan analysts, led by Natasha Kaneva, wrote.

"At face value, and assuming no policy, supply or demand response, Russia's actions could push Brent oil price to $90 already in April, reach mid-$90 by May and close to $100 by September," they said.

"This price hike could be further amplified by the even-oddspossibility of the OPEC+ alliance extending in June its oil productioncutbacks to the end of the year," the analysts said.

In Wednesday dealings, Brent crude for May delivery (BRNK24) (BRN00), which expires at the end of Thursday's trading session, was at $85.75 a barrel, down 50 cents, or 0.6%, on ICE Futures Europe. The contract is trading nearly 12% higher year to date, FactSet data show.

However, there are "multiple levers that can quite effectively mitigate the impact of the high prices," the J.P. Morgan analysts noted.

The most obvious "rebalancing mechanism" in the short run is a policy response in the form of a drawdown in crude stocks from the U.S. Strategic Petroleum Reserve, they said.

They pointed out that a rise in oil prices this would keep pressure on the U.S. administration in the run-up to the November presidential election - with U.S. gasoline prices likely to climb to $4 a gallon by May, which the J.P. Morgan analysts said would be the highest since the summer of 2022.

The SPR, following the Biden administration's record drawdown in 2022 and efforts to refill it, still holds "ample crude to protect the nation's strategic needs and offer a cushion against price shocks," they said. They estimated that the U.S. administration has the "policy space" to release up to 60 million barrels of crude oil.

Aside from the SPR, demand destruction offers another potential "potent countermeasure" to high oil prices, the analysts at J.P. Morgan said.

"The impact of the rising oil prices on consumption depends heavily on whether the source of rising oil prices is a demand shock or a supply shock," they wrote.

In an example of "demand shock," robust economic expansion in the 2000s, lifted by China's accession into the World Trade Organization in December 2001, required a lot of oil, leading to strong growth in GDP and rising oil prices, they noted.

In contrast, a "negative shock" to oil supply that boosts prices and dampens consumer purchasing power "will weigh on economic growth and depress oil demand," they added. The Arab oil embargo of 1973 and the Russian invasion of Ukraine in 2022 are examples of a "supply-driven surge" in oil prices.

"The speed of the price move also matters," the analysts said. "Sharp and rapid rise in the oil price will have a larger effect on household sentiment and spending as consumers have less time to adjust."

Oil prices substantially above $90 can cause "severe disruptions" in global oil demand, given the U.S. dollar's strength and high borrowing costs, they wrote. That, in turn, could lead in lower oil prices.

There are preliminary signs that consumers might already be cutting back on fuel consumption, even though fuel prices today may not be close to "consumers' pain threshold" observed in 2022, the analysts said.

Weekly trips taken by American drivers reveal that trips covering three to 100 miles have tracked lower since the end of January, "coinciding with the period when U.S. gasoline prices began to rise," they said.

Given the "multiple counter-measures that could act as a suitable rebalancing mechanism" to high oil prices, J.P. Morgan opted to keep its oil price forecast unchanged.

It forecasts a 2024 average of $83 a barrel for Brent crude, with prices averaging $84 in the third quarter and $85 in the fourth quarter of this year.

-Myra P. Saefong

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03-27-24 1354ET

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