While prices at the pump in the U.S. were easing in late May, oil industry veterans were sounding the alarm on depleting inventories and a potential oil price spike. Since then, there have been media reports of more oil cargoes transiting the Strait of Hormuz. Oil prices retreated as hopes of a peace deal culminated, with plans to sign an agreement in Switzerland this coming Friday. For energy infrastructure, the day-to-day oil swings are arguably more noise than substance. However, this piece will take a closer look at oil market dynamics, why even oil companies do not want $150 oil, and what midstream investors should focus on when it comes to oil prices.
Key Takeaways
- In late May, energy executives were highlighting the rapid depletion of global inventories and the risk of an oil price spike.
- With a potential peace deal and reopening of the Strait in the works, Brent oil prices fell below $90 per barrel last week and saw more pressure on Monday, but that doesn’t mean oil prices won’t rise from here.
- Instead of focusing on day-to-day oil price moves, midstream investors should be keeping an eye on futures prices, which are over $70 per barrel next year for the U.S. benchmark and will be more impactful for producer drilling plans.
Depleting Inventories Drove Concerns of an Oil Price Spike in Late May
At a conference in late May, executives from Exxon (XOM) and Chevron (CVX) highlighted the severity of inventory depletion as this important buffer for the oil market begins to diminish. Chevron’s CEO discussed the potential for physical prices to see upward pressure into June and July.
Exxon Senior Vice President Neil Chapman discussed the possibility of a price spike as inventories reach low levels, with models forecasting $150 or $160 for Dated Brent crude. In contrast to the Brent futures often cited, Dated Brent is a better reflection of physical prices and the spot price for oil ready to be shipped. Importantly, Dated Brent sets the price for the majority of global oil trades.
Dated Brent had reached a high of $144/bbl on April 7, while Brent futures were only at $109/bbl. A distortion between physical and paper markets has been common in recent months. However, the spread between Dated Brent and Brent futures was fairly negligible at the end of last week, with both closing around $88/bbl.
Oil at $150 or $160/bbl Is Not Good — Even for Oil Companies
Investors may think that oil producers would be delighted by oil at $150+ per barrel, but that is not the case. That price level destroys demand, and with petroleum such an important input for so much of the economy, the impact of high prices would be broadly painful. The concern is that the global economy could plunge into a recession. With that perspective, it makes sense that oil industry executives were highlighting this risk.
Politicians likely realized that strategic oil releases and measures like lifting sanctions on Russian petroleum cargoes at sea could only buy so much time with the Strait of Hormuz effectively closed. In that vein, President Trump revealed last week that more than 100 million barrels of oil had secretly been moved through the Strait with the help of the U.S. military.
While modest relative to the amount disrupted since the war began, the secret shipments could provide context to why prices have not risen more. A dramatic drop in Chinese imports has also been credited for avoiding a more severe price spike, with China having aggressively built their reserves over the last 18 months, according to comments from Chevron’s CEO.
Is the Relative High in Oil Prices Behind Us?
Oil prices have fallen as optimism rises for a peace deal and a reopening of the Strait of Hormuz. The front-month Brent contract closed at $87/bbl on Friday — its first close below $90/bbl since March 10. Prices were under pressure again on Monday following the announcement of plans for a peace agreement over the weekend.
It may feel like oil prices are poised for a continued downtrend. That said, even as the Strait reopens, it is expected to take time for flows to return to normal levels. Vessels need to reposition, and ships may also need confirmation that there are no mines in the Strait. There are also some lingering questions around infrastructure in the region and how quickly operations can ramp back up.
The Short-Term Energy Outlook from the U.S. Energy Information Administration (EIA), published June 9, assumed flows would only start to slowly resume in 3Q. With that timeline, the EIA forecasted that production and trade flows would not return to normal until early 2027.
While making oil price calls is tough, especially in this tape, it bears noting that oil tends to overreact in either direction. Even with a successful peace deal, inventories are likely to continue to fall near term, which could put upward pressure on prices. It remains to be seen whether the buffers that have helped mitigate the oil price spike to this point will continue to be effective until volumes return to more normalized levels. For example, at the recent run rate, the releases from the U.S. Strategic Petroleum Reserve would be exhausted around the end of August.
Midstream Investors Should Look Past Oil Volatility to Focus on Futures Curve
For midstream investors, the day-to-day, headline-driven volatility in oil should not be a major concern. The greater focus should be futures prices for oil, particularly into 2027 and even beyond. Eventually, the world will need to restock oil, which should support future prices. Additionally, one could argue that a greater risk premium should be embedded into the curve, given the potential for the Strait to close again.
For midstream, the futures curve is what matters, as it is what producers will use to determine their drilling plans. Compared to the start of the year, 2027 futures prices for the U.S. crude benchmark have risen around $15/bbl to over $70/bbl. The EIA is currently forecasting that U.S. oil production will grow by 0.43 million barrels per day on average for 2027, compared to prior expectations for oil production to decline next year. Midstream has long enjoyed tailwinds from growing natural gas demand, but now growth opportunities related to oil are more likely, given a stronger price outlook.
Bottom Line:
To say there are a lot of moving parts in the oil market today would be a major understatement. For energy infrastructure, a lot of this is noise. Instead of focusing on day-to-day moves in the current futures contract, midstream investors should look more to the futures curve, particularly prices into 2027.
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