Recapping Oil Markets in 2022 and Looking at Oil Markets in 2023

As 2022 ends, it’s important to take a break from our daily reports and reflect on how the oil markets traded this year and the key things to look out for in 2023.

Firstly, we wrote 226 Daily reports (ODMRs) and 6 China Monthly reports out of a possible ~250 business days each year, we plan to write more in 2023 and we are learning to juggle report writing when we travel. We also plan to experiment from writing different type of reports from time to time (more charts/less commentary, longer articles, and will be asking client feedback)

Secondly, we wrote a similar annual oil market recap this time last year (Oil markets in 2022). We have broken down below what aged well and what didn’t. Overall, we were happy with how we saw the markets this time last year, but obviously, like most, we missed the elephant in the room, which was the Russia/Ukraine conflict. See below how our last year’s prediction fared.

2022 Predictions made last year	How it turned out	Comment
Covid becomes endemic		This was written last December when Omicron variant was surging globally. This eventually became the last major variant as vaccine developments remained ahead. Global mobility ex China rebounded quickly. As we write this again, China has finally decided to scrap bulk of their zero Covid policies.
Chinese commodity imports remain high		Despite commodity imports not falling off due to Zero Covid policy, Chinese commodity imports were ~20% below the 2021 highs. Maybe 2023 will be the year of new highs for Chinese commodity imports.
Power grid remains challenged		Despite the power grid challenges, the worst possible scenario of rolling blackouts was avoided in countries such as India/China/W.Europe. China took its energy security very seriously as it ramped up coal production (10% y/y) which remains a very diesel intensive process. Power grids will continue to remain challenged and oil in power gen will continue to be used intermittently.
Energy subsidies grow in the West		Energy subsidies via tax breaks, cash handouts, etc became the norm. In fact, it was too generous energy subsidies that kicked out Liz Truss in the UK in only 44 days. Pump prices became political anytime when flat price was over $100. With prices off its high, this debate could be reignited when the next spike happens.
Global Flights rebound and hit new highs		Despite Covid in the rear-view mirror, global flights and jet fuel demand didn’t hit new highs. China domestic and international were the main reasons behind this. At the time of writing, despite China opening, domestic flights are down by 50% from its highs.
US crude production continues to get downgraded		Despite WTI averaging ~$95 in 2022, we did not see the dramatic rise in oil rig counts EIA Short-Term Energy Outlook (STEO) was expecting US 2023 production to grow by 1.05MMBD in June, which was revised downto 0.46MMBD in its latest report.
Strong Brazil oil demand		Brazil diesel and gasoline continued to inch higher as the country benefits from the wider minin boom. With China reopening, Brazil economy should benefit (iron ore and other commodities) and keep oil demand strong in LATAM.
Strong Indian Light Ends Demand		Despite higher pump prices, Indian Gasoline demand continued to hit new highs as the growing Indian middle classes continues to boost oil demand. Diesel was the laggard this year in India but November saw a record high print. With India planning to take in cheaper Russian crude, this should result in cheaper refined products that should keep demand elevated.
Food / Fertiliser crisis		The world was heading towards food / fertiliser crisis before the Russia / Ukraine war started. Food prices have come off the peak but remains structurally higher and are at levels which had previously triggered the Arab Spring movement in 2011.
Spec positioning will rebound		We got this horribly wrong. Even when all the stars were aligned for maximum bullishness, spec length in key markets barely moved. Aggregate Open Interest in Brent and WTI continue to hit multi year lows. Strong backwardation earlier this year which gave a strong roll yield failed to attract passive investors.
Inflation will continue to be a hot topic globally		Persistent inflation continued to be a headache for global policymakers. The debate of “inflation is transitory” was finally over. It also led to a sharp pullback in risk assets as interest rate rises were done quickly and steeply. Oil which normally benefits in an inflationary environment historically, however struggled as it was dragged down by recessionary fears. However, oil equities continued to outperform and stayed resilient despite the flat price drop, further highlighting the structural oil supply issue.
Dollar flows will remain elevated and remain a headwind for commodity markets		Dollar Index surged this year and despite coming off its highs recently, remain at multi year highs. Positioning has come off sharply (chart below) which means2023 is prime for another dollar spike. This can cause major headwinds in all commodity markets despite their underlying supply/demand balances.

What a difference one year makes, as this time last year the world was freaking about the Omicron variant. Given Covid is almost forgotten in most parts of the world except for China. At the time of writing, China announced to remove its last Covid barriers of inbound arrival quarantine.

2022 was the year commodity markets were supposed to break. Even before the Ukrainian invasion, commodity markets were looking structurally challenged (oil’s low spare capacity, European power grids, and rising food prices). When Putin invaded Ukraine in late February, all the commodity markets structurally changed and even if there is some form of ceasefire / negotiations in 2023, these markets are not going back to how they were in 2021. For oil, 50 years+ of trade routes were structurally altered in 2022.

However, despite these seismic events, most of the commodity markets have come off sharply off its highs and mean reverted (table and graph on the left is YTD 2022 avg vs 2021). Even European Nat Gas, one of the most exposed to Russia, prices are now currently lower than this time last year. This could be due to the mild weather, but even deferred contracts like Cal-23 TTF have dropped over 40% and now at the lowest in over 6 months. Financial markets remain incredibly resilient and never underestimate human ingenuity or traders when huge arbitrages exist. Demand destruction or efficiency gains continues to happen at real time which is hard to track in lagged official datasets.

As we enter 2023, we are not writing the “key trends to look out for”, this is mainly because the markets continue to roll on, and structural issues persist. Most of the commodity markets continue to kick the can down the road and it “sounds like a next-year problem”.

Another point to note is that by speaking to many various market participants, it’s becoming increasingly clear that the old way of looking at oil markets (i.e inventory levels, detailed supply/demand balances, oil flows, etc) is becoming less relevant. Back in the day, a good global oil balance was in the range of +/- 0.5MMBD, now it’s hard to get a global balance right within 5MMBD due to the dark blind spots that is Russia and China. As a result, technicals, positioning data, and correlation with other financial markets have regained their importance in the oil markets.

Whether this trend was a one-off in 2022 or we might see a repeat in 2023 if oil markets fail to rally despite China opening up, remains to be seen. Most traditional indicators point to a structurally tight oil market, with the wildcard that is recession offsetting these factors. Most of the financial markets have priced in some form of recession, but the big variable is whether the recession will be as big as 2008/09.

Whether you are in the bull or bear side, there is no denying that oil is currently cheap. We were recently in Houston and filled our rental car at $2.70/Gal. To use the economics term “rent-seeking”, any material upside in flat price or price of crude oil continues to get taken advantage by other key variables in the supply chain. Earlier this year, it was the refinery margin when Diesel and Gasoline cracks took the bulk of the upside in the oil supply chain. Now with only diesel crack elevated, oil’s surplus value continues to get extracted by shipping. If Russian oil is at $60/bbl+, and Diesel is at $120/bbl+, shippers and refiners will try to extract maximum value in this long-lasting arbitrage. Historically, most shipping spikes were temporary as in an efficient globalised world, shipping rates were depressed. However, with a Covid hangover of reduced new ships being built and Russian oil being diverted from pipeline to tankers, it’s hard not to be bullish about freight rates. We have to go back to a 2003-08 market when we had surging shipping rates due to China’s commodity appetite, however, in this current market of depressed flat price and high freight rates will have unintended consequences. Traditional arb routes will continue to get challenged in a structurally high freight market. 

Lastly, as we wrap this up, it’s hard not to mention some of the black swan events that can occur that will structurally change and make all the existing assumptions redundant. Just like we wrote oil markets in 2022 last year, we failed to mention Russia/Ukraine. Some might have seen it coming, but this was a big surprise that no one had priced in the markets. As Donald Rumsfeld once said there are “known knowns, known unknowns, and unknown unknowns”. In theory, unknown unknowns cannot be predicted, but here is our half-hearted attempt at it.

Some black swan events to think about and possible price reactions that can happen. If you are still reading this far down our post, please feel free to comment and add more scenarios.

Happy new year and we wish everyone all the best in 2023!

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Black Swan event	Likely price action
China invades Taiwan	Even though very unlikely with the way the world has treated Russia post invasion, if this does happen, its bearish all commodities.
Putin gets assassinated	Immediate selloff but higher flat price eventually due to no likely successor.
Rolling blackouts in Western Europe	Short term bearish due to de-industrialisation. But long term bullish gasoline / diesel due to death of EVs.
Huge oil spill / accident from one of the sanction evading oil tankers	With the list of old tankers growing due to increasing volumes of sanctioned crude, an environmental disaster becomes very likely. With no one to pay for the oil spill, this will increase spotlight on oil tankers.
Russian refinery accident	Sanctions will continue to disrupt key maintenance cycles for Russian infrastructure. Refineries that are complex to run are more prone to accidents if not maintained well. It will tighten product markets further and add a risk premium on Russian refined products.
UAE leaves OPEC	If oil markets continue to selloff in 2023, OPEC will struggle to convince members to cut output further. UAE, the only member with large growth plans, leaves OPEC. A bearish development, if this happens, as OPEC unity has defied sceptics so far.