Oil prices lower for longer
Web Posted on : Sun, 09 Aug 2015
Download the PDF version of this weekly commentary in English
Oil prices have again collapsed to sub-USD50/barrel levels. A bear market in Chinese equities has shaken confidence in the global growth outlook while oil markets have been surprised by continued increases in global oil output, despite lower oil prices. Therefore, the current glut in world oil markets is likely to persist well into 2016. From 2017, as producers and consumers adjust to lower prices, oil markets should begin to tighten, leading to gradually firmer prices. As a result, we forecast oil prices to average around USD55/barrel (b) in 2015-16 before rising to USD60/b in 2017.
Oil prices rallied 45.5% during the first half of the year, mainly driven by improving expectations for global growth (see our commentary on 14th June, Is the Recovery in Oil Prices Supply or Demand Driven?). Subsequently, oil prices have lost almost all the gains, falling back below USD50/b at the beginning of August. A mixture of supply and demand factors were behind the recent drop.
The weaker demand picture was mainly driven by concerns about global growth emanating from China. The largest drops in oil prices were at the beginning and end of July as sharp selloffs in Chinese equities triggered concerns about potentially negative knock-on effects on the real economy. China is highly important for global oil markets—on 3rd August, oil prices fell 5.2% after disappointing manufacturing data was released in China. Looking at the overall global picture, the IMF revised down its 2015 forecast for world GDP growth by 0.2% to 3.3% in July.
On the supply side, the agreement to remove international sanctions on Iran and persistent increases in global production have further weakened the outlook for prices. An Iranian nuclear agreement was initially announced in April with the final details made public on 14th July. Assuming international sanctions are lifted in the next few months (ratification by the EU, US and Iran itself is still required), Iranian production would increase.
Elsewhere, supply has increased, confounding expectations of production cuts in response to lower oil prices. Saudi Arabia’s production rose to a record 10.3m barrels/day (b/d) in July, according to the International Energy Agency (IEA). Production is also rising in other OPEC countries, particularly Iraq (4.1m b/d in June, up from 3.3m on average in 2014). Total OPEC production was 31.7m b/d in July, up from 30.3 on average in 2014. OPEC made no changes to its production target in its meeting at the beginning of June, bolstering the outlook for supply. In the US, where high-cost shale oil producers were expected to be hit hardest by lower oil prices, production has been resilient, averaging 9.5m b/d so far in 2015, compared with 8.7m in 2014.
What does this mean for oil prices going forward? The latest report from the IEA suggests that world oil markets will be oversupplied by around 1.9m b/d in 2015. Based on the IEA projections, we expect another supply glut in 2016 of around 1.1m b/d. OPEC production should remain elevated—Iran is expected to add around 0.7m b/d to global production by the end of 2016 and Saudi Arabia is expected to maintain current output levels. Meanwhile, non-OPEC production shows no signs of slowing down either. The IEA expects US production to rise by 0.3m b/d in 2016. Rising supply is likely to offset any pick up in global demand. As a result, we expect oil prices to remain broadly flat at around USD55.5/b in 2016. One caveat to our supply outlook is the risk of supply disruptions from security or geopolitical factors, which could lead to higher than forecast prices.
From 2017, oil markets should begin to tighten, leading to rising oil prices. In terms of supply, non-OPEC producers will eventually be forced to cut back on investment in response to lower oil prices, leading to slower output growth. Production with higher costs is likely to be the first to be impacted, including shale oil in the US; oil sands in Canada; and offshore producers in the Gulf of Mexico and off west Africa. Major oil companies have already reportedly cut back on USD200bn of capex on new projects (USD5.6bn in Canada, the worst impacted region), which will lead to lower future production growth. On the demand side, oil consumption is likely to increase in response to lower prices, mainly in emerging markets, and as global growth is expected to rise. Therefore, from 2017, slower supply growth coupled with rising demand should erode excess supply in global oil markets, leading to a gradual increase in oil prices to around USD60/b.