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As anybody who has ever traded oil knows all too well, the long-term forecasting of prices for the commodity is a tricky game to play. The problem is that there are just so many influences on the price that it is hard to know where to look, or what will drive moves at any given time. In theory, the influences are simply supply and demand, but those two basic things are themselves driven by a whole host of other things. The list would include global economic health and growth, the capex and production decisions of companies in the space, geopolitics, including the internal politics of OPEC and their allies, the weather, and even the transition away from fossil fuels to cleaner energy sources. And that is just the beginning of the myriad of issues confronting prognosticators of oil prices.
That long-term unpredictability and the complexity of the pricing equations is part of the appeal of oil for traders. It creates short-term volatility, with big intraday moves, both up and down, and volatility is a trader’s friend. However, that volatility and unpredictably make oil difficult to forecast over time, which is what stock traders and investors usually try to do. It is tempting, given the issues, to just not bother. After all, isn’t oil on its way to obscurity? Should an investor really worry about the price of an increasingly obsolete resource?
The problem, though, is that oil, either as gasoline or diesel, still powers around 90% of the world’s vehicles and despite some recent technological advances, almost all of the global shipping and transportation infrastructure. As the world saw very clearly last year, high oil prices impact prices on a wide range of goods and can be at least a contributing factor, if not the principal factor, in inflationary pressure. In a world where inflation, and central bank responses to it, are the most important driver of stock prices by far, therefore, investors need to pay attention and should have some kind of base case for oil in the coming year.
With all of that said, what is the most likely scenario for oil prices in 2023?
2022 was, as you can see, a year of two distinct halves for CL, the main WTI crude futures contract. The first half of the year was a “perfect storm” for prices, with Russia’s invasion of Ukraine hitting at a time when supply was already restricted, both by post-pandemic disruptions and by the hesitancy of oil firms to invest in long-term projects in a hostile global regulatory environment. That all came as global growth was strong as demand recovered quickly from the lingering effects of the pandemic. People started to travel again, and workplaces opened up. The empty roads of 2020 and to a lesser extent 2021 became just a pleasant memory for drivers.
In the second half of the year, though, the focus shifted. Central banks began raising rates, bringing global growth into question, and a resurgence of Covid in China effectively shut down one of the biggest drivers of that growth. And that all happened just as the $100+ per barrel prices in the first half of the year and a growing awareness of the strategic importance of oil encouraged increased output, with the U.S. rig count in particular climbing steeply.
There were some violent swings, but the net effect is that crude ended the year right around where it began. It was basically, from a year-long perspective, a lot of fuss about nothing. That brings us to the next question: What about 2023?
Well, if you focus on the Fed and believe what they are saying now, it should be more of the same thing. They intend at this point to keep raising rates for a few months next year, then pause for a while before starting to lower them. That would slow growth significantly, and therefore limit oil demand. Of course, a cynic would point out that believing the Fed is not particularly smart — after all, just over a year ago, Jay Powell was still insisting that inflation was transitory and the FOMC were forecasting maybe one or two small rate hikes in 2022. That aside, though, it is reasonable to expect a tough start for oil on the demand outlook side.
Supply factors may also be on the bullish side for oil prices early in the year. The war in Ukraine looks far more likely to escalate than be resolved right now, and the lower prices in the second half of the year will have discouraged increased output. Perhaps the biggest factor on the supply side, though, is OPEC+. The two main players in that group, Russia, and Saudi Arabia, have a history of using oil as a political weapon and Joe Biden’s recent trip to the Saudi capital notwithstanding, neither has any love for his administration.
What we will probably see is what we saw this year, where Adam Smith’s “invisible hand” does its thing and rising prices both decrease demand and increase output, bringing prices back into balance somewhat. However, U.S. output will be starting from a higher base, with less room to increase rapidly, and any OPEC+ squeeze will not be short-term. We will likely see increasing demand in the second half of the year but with limited supply, pushing prices higher.
At some point, that will create a problem for the Fed as it will add back inflationary pressures, another reason why investors need to stay alert and agile as I said yesterday. But, at least for the first half of 2023, stronger oil will be a sign of increased confidence in the ability of the Fed to engineer a soft landing, so it will probably be supportive of stocks. That “decent first half, worrying second half” outlook for next year is the opposite to what most analysts expect for stocks, so if things do pan out that way, there will be some big opportunities.
In short, as complex and baffling as oil can be at times, investors should keep a close eye on it in 2023, when it could well be an early indicator of shifts in sentiment.
* In addition to contributing here, Martin Tillier works as Head of Research at the crypto platform SmartFI.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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