Dennis Kissler, BOK Financial

In the early days of 2024, crude oil prices dropped rapidly, with West Texas Intermediate (WTI) down more than 4% and Brent down more than 3%. The fall in prices was sparked by Saudi Arabia’s state-owned oil company having cut the prices of its Asia crude exports over the weekend to the lowest levels in more than two years. This move was due to China’s struggling economic recovery post-COVID and the resulting decreased need for oil.

So, will we see a freefall in oil prices during these early weeks of 2024? I still don’t think so.  While crude oil supply and demand fundamentals are favoring a global supply surplus, there are underlying issues that should keep a floor under prices.

In the near-term, the conflicts between Russia and Ukraine in Eastern Europe and Israel and Hamas in the Middle East are keeping oil prices higher than we might expect, given the drop in Chinese demand. While both wars seem to be on a path of escalation at the time of this writing, it’s the Israeli/Hamas conflict that is taking precedence, as the tensions have now expanded into Iran and the Red Sea area.

Red Sea disruptions could cause oil shortage

The disruption of shipment through the Red Sea would have a major impact on global markets, particularly the energy market. Already, we’ve seen Houthi forces in Yemen using Iranian intelligence and weapons to target ships. Although they have said they’re targeting only Israeli ships, that doesn’t seem to be the case.

If the conflict in the Red Sea continues to escalate, exported crude supplies out of the straits of Hormuz could be cut, along with Iranian crude exports in excess of 1.5 MMbbl/d. Such an event a year ago was not even on the radar and now could immediately flip global fundamentals into a crude shortage.

Other factors buoying oil prices

Meanwhile, the U.S. government has been continuing its efforts to replenish the Strategic Petroleum Reserve (SPR), which is requiring a constant purchase of crude. Most recently, the Department of Energy said it wants to buy as many as 3 MMbbl of U.S.-produced sour crude oil for delivery in April. (Sour crude is more difficult and costly to refine because of its high sulfur content, making it less expensive than sweet crude oil.)

Large purchases like that are necessary for the SPR to be replenished, given how much the reserves have been drawn down. Approximately 290 MMbbl have been released since 2021, including the record 180 MMbbl sold in 2022 to help fight high oil prices after Russia invaded Ukraine. The current rate of refill (or contracted re-fill so far) is 7.6 MMbbl, with 14 MMbbl more supposedly contracted. This all means a long road ahead during which more purchases will be needed. While it is evident that the buyback will be much more orchestrated than the heavy selling that took place in 2022, there seems to be a floating bid under prices, at least through most of 2024.

Finally, heightened environmental regulations and economic sanctions likely will support oil prices. The last run-up in prices resulted in some relaxation of environmental policies and some sanctions to be eased, which allowed oil exports from China, Russia and Venezuela to enter the market. Global supplies increased quickly. However, now that prices have receded, it’s more likely than not that environment regulations will be retightened and economic sanctions will be more heavily enforced, pulling barrels from those countries back off the global market.

What about China?

Of course, demand will remain an issue, but even with the continued slowdown in the manufacturing sector, global demand (especially for jet fuel) has remained well above most expectations. If we continue to see the U.S. economy head toward a soft landing (as opposed to a recession), the seasonal spring demand could once again outperform most estimates. One thing that will remain in 2024: market volatility.