Societe Generale’s Michael Haigh and Jeremy Sellem argue that Oil has underperformed historical shocks despite a 14% loss in global crude supply. They highlight ten offsetting forces, including Chinese demand destruction, structural shifts that make prices feel less painful, inventory drawdowns, Washington’s reassuring messaging, and a deceptively soft forward curve, concluding that higher Oil prices will ultimately be needed to rebalance the market.

Oil shock remains underpriced

"Over the past two weeks, one question has come up in almost every client meeting: why, given what is arguably the largest energy shock on record, have oil prices not rallied as sharply as expected? With global crude supply down around 14%, double the 7% disruption seen during the 1973 Arab embargo, prices have risen only 30%, down from the 60% at the end of March. This is considerably lower than the 134% surge witnessed during that 1973 shock. Why? In this CCA, we set out 10 key arguments inspired from our recent client discussions to explain this apparent disconnect."

"Physical markets are tightening, with falling inventories and growing prompt supply strain, yet prices remain unusually subdued relative to fundamentals. This disconnect is partly driven by oil consumers running down cheaper inventory rather than bidding for expensive spot cargoes. This strategy is inherently temporary as stocks decline."

"The forward curve is sending a deceptively comforting long-term signal. Deferred prices remain too soft to support the level of investment required for sustained non-OPEC supply growth. While the market appears to be pricing stability, the economics implied by the curve are insufficient to underpin the capital spending needed over time. In effect, long-dated prices are underestimating what it will take to keep global supply adequately balanced. At the same time, producer hedging at currently elevated prices further out the curve is reinforcing this softness, anchoring long-dated prices and creating the perception that current levels are fundamentally justified."

"The market will require higher prices to restore balance. Several structural pressures are pointing in the same direction: strategic reserves will need to be rebuilt, inventories are unlikely to remain comfortable without incremental supply, and new production requires stronger returns to move forward. Taken together, the longer-term equilibrium price for oil is likely higher than what the current forward curve implies. Ultimately, the continued drawdown in inventories will force a reassessment of what price level is needed to keep the market adequately supplied."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)