Oil: OPEC has 'hands on the steering wheel' of energy market

Crude oil futures (CL=F, BZ=F) momentarily pause their price rally after hitting multi-month highs, remaining elevated around various geopolitical tensions including the ongoing conflict between Israeli and Hamas forces in the Middle East.

CIBC Private Wealth US Senior Energy Trader Rebecca Babin weighs in on the oil inventory pressures associated with OPEC+'s production cuts and the Russia-Ukraine War, looking ahead to the range where oil and US gas prices could eventually settle into.

"Right now what they [OPEC+] have is a beautiful position of controlling the market. They've got their hands on the steering wheel here. They don't want to lose that," Babin tells Yahoo Finance. "You let it go too far, you get SPR (Strategic Petroleum Reserve). So, let's bring back some barrels. I think this puts a damper on this rally to $100 [per barrel] that some people are talking about. And he second big factor I think is demand destruction. You can't just have an explosive rally to the upside and think demand is going to be completely inelastic."

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Luke Carberry Mogan.

Video transcript

MADISON MILLS: Our next guest warning of several risks that could emerge here. So we have Rebecca Babin, CIBC Private Wealth US senior energy trader joining us now to discuss. Rebecca, thank you so much for coming in studio. We appreciate it. You outline a lot of risks in this recent research that you sent over to us. Talk to me about the single biggest risk that you think investors should be keeping in mind for downside in oil.

REBECCA BABIN: I think the biggest risk is that we see a response either from the US or from OPEC bringing back barrels and kind of offsetting the deficit that's been currently priced into the market. So the SPR was used very aggressively in 2022. And although, we won't be able to withdraw that many barrels on this episode, there are estimates that 60 million barrels can be released heading into the election.

That's very likely to happen, as you mentioned, if gasoline prices continue to tick higher. I think the bogey there is getting towards $4 a gallon in gasoline. That's going to panic the administration. They're going to try to unleash some barrels. It's a very blunt instrument. We saw how aggressively it was used, and it can really cause a downdraft.

So, I think, OPEC is going to look at that and say, I've lost market share to the US, whether it's US producers or the US SPR, for two years. I've got 5 million barrels of production offline. Let me get ahead of this and bring back some of my production, offset a spike, and maintain control of the market.

Because right now what they have is a beautiful position of controlling the market. They've got their hands on the steering wheel here. They don't want to lose that. You let it go too far, you get SPR. So let's bring back some barrels. I think that puts a damper on this rally to 100 that some people are talking about.

And the second big factor, I think, is demand destruction. You can't just have an explosive rally to the upside and think demand is going to be completely inelastic. It's not elastic at certain price points, but the trigger, the bogey is Brent on $90 where we start to see some demand destruction. So that's what I'm looking at.

SEANA SMITH: So what do you think the downside then more specifically looks like in prices? So here we are at least for Brent just below right around, I guess, you can say, $90. When we talk about downside here potentially, how big of a drop do you think we could see in prices?

REBECCA BABIN: So that's a great question. I don't think it's going to be this colossal sell off because demand actually does look good. I'd say $80. If we get to Brent $80, a nice $10 move, that's still significant. You start to look at reestablishing some longs because, ultimately, the demand has looked pretty good. Supply is not exploding higher.

US production actually, start of the year has been a little soft. I think it's going to come back. But there's this fear from 2023 where the US overproduced estimates that it would happen again. And so far that's not happening. So I think the balances look solid to support fundamentals, support $80 in Brent.

MADISON MILLS: How low would oil have to get for President Biden to not tap SPRs.

REBECCA BABIN: You know, that's also a good question. I think if we're anywhere below in the mid $80, high $70s, low $80s, I think we're OK as long as gasoline prices may be below $3.75 at the pump. A little bit of that depends on how the narrative shifts going into this election, how aggressively he's attacked on that, what the rest of the inflation picture looks like. But if we were to isolate, I think $3.75 at the pump is maybe where we start to feel some sweat from the administration.

SEANA SMITH: When it comes to what that could then potentially mean for inflation-- I bring this up just because at least over the last, I guess, several weeks at this point, as we've seen the steady climb higher in the price of crude, there has been this renewed, I guess, estimates out there, forecast from a number of strategists on the street that that's going to then contribute, obviously, to inflation. It's going to keep inflation maybe at the higher levels that we've seen. If we do see the drops that you're expecting there, will that be enough in order to reflect some improvement on the inflation front?

REBECCA BABIN: So good question. Again, I don't think it will because I think they strip out energy because there's so much volatility. The core number is more reflective, and there's been such extreme moves in energy. And again, they can always fall back on that's geopolitical. That's outside our control. That's an ebb and flow.

So I think it helps the broader narrative in terms of how people feel about inflation. And as we know, the Fed does look at those expectations about what we're projecting and consumers feel about inflation as part of their process. But if we dial down into the hard numbers, I don't think it necessarily changes the picture.

MADISON MILLS: Right, it's more of a sentiment push--

REBECCA BABIN: Yes.

MADISON MILLS: --than anything else it sounds like. You mentioned the geopolitical, so I'm curious we've got the Middle East, Russia, Ukraine, China, additional factors. Which of those do you think is the biggest risk in terms of downside risk for oil?

REBECCA BABIN: So that's a good question. So I think if we look at the amount of premium that's priced into the market for geopolitics, I think most of it's associated with the Middle East, which is actually where, I think, there's less supply risk than there is in Russia and Ukraine. We're actually seeing refiners get hit in Russia. Whereas in the Middle East, what we're seeing is routes diverted.

And there's not actually a really strong case for supply to be disrupted in the Middle East. However, that's not where the premium is. We get a ceasefire, you're going to get a huge leg lower. I think $5-- $4 to $5 bucks I think that's how much is priced in if we get a ceasefire between Israel and Hamas.

I'm still watching Russia, Ukraine. I think that if that continues to escalate and we see more targets hit there, that's where real supply could get hit. So I think maybe the markets looking the wrong way when the puck is over there.

MADISON MILLS: So helpful, Rebecca. Thank you so much. I really appreciate you joining us and coming in studio. Thank you.