New Oil Price Forecasts
Brent finished 2015 below $40/b following December’s OPEC meeting that left the organization’s strategy essentially unchanged, against a background of still ample supplies and rising inventories. Although the outcome of the meeting was largely as expected, it was viewed as bearish, driving substantial short positioning. 12m spreads have widened, with longer-term prices reflecting a tighter market ahead.
Outlook Has Weakened Since December
The fundamental outlook has weakened since December—U.S. demand has stalled (partly due to unseasonably warm weather), U.S. output has stabilized and the Iran deal has progressed more smoothly than expected. In our base case, we see global commercial inventories continuing to grow, although at a slower pace, through 2016, but with the market tentatively reaching balance by year-end, albeit with a massive inventory overhang. Assuming China continues to fill its strategic petroleum reserve at a rate of around 0.3 million barrels per day in 2016, commercial inventories should begin to decline in Q3, providing price support.
Market Sentiment Also Deteriorated
Market sentiment has also deteriorated—a key component in price determination as long as the market remains oversupplied. The outcome of the latest OPEC meeting, along with Saudi Arabia’s budget, dispelled any lingering expectations of an output cut to support prices, and the failure to agree on an output target heightened anticipation of a price war between the two major producers once Iran’s oil returns to the market. We believe these fears are overdone, but they will still put downward pressure on prices in the near term. Dollar strength will continue to weigh on all commodity prices, including oil, but fundamentals are likely to predominate.
Downside Risks, but Prices to Recover
Although there are near-term downside risks, we expect prices to recover from current levels. However, we have revised down our 2016 average forecast to $47/$46 (Brent/WTI; previously $56/$52) to reflect the weaker fundamentals, poor sentiment and the lost opportunity to put a dent in inventories in Q4.
A sustained draw in U.S. inventory could trigger a price recovery in Q2, particularly with U.S. shale output contracting. Other things to watch for include more distress in the shale oil sector, particularly around the time of the credit renewals in April 2016 if prices remain this low, or signs of output declines elsewhere in the world—particularly Russia. However, the substantial inventory overhang and output responsiveness of U.S. shale will limit the upside to prices, keeping them below marginal cost and continuing to suppress investment plans.
Drivers of our upside scenario could precipitate a faster-than-expected recovery toward marginal cost, but sharp spikes are unlikely given the substantial inventory overhang, unless there is a significant actual supply disruption. With prices now approaching average break-evens (including for producing assets), further downside should be fairly limited, even in the adverse scenario. Prices could stay weak through H1, but this would ultimately result in further output curtailment and some price recovery
By Roubini Economics Oracle
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