Oil prices jumped on Monday to their highest since November after Goldman Sachs said it was more positive about the market and on growing Nigerian oil output disruptions. Such supply disruptions have likely pushed oil production below consumption levels, for the first time in two years. Today,Roubini Econoteam assess whether the supply/demand dynamics imply this will continue.
|Expect Sluggish Oil Prices for Another Year|
|Negligible Supply Growth…
Oil supply growth is likely to be negligible this year as OPEC gains are offset by a sharp non-OPEC decline. In 2017, some shale output may come back online, but the impact of lower prices and constrained capital expenditure will become more evident elsewhere in non-OPEC producers.
With Iran potentially back to capacity, growth potential in OPEC will also be limited. However, potential demand growth is such that the market surplus is unlikely to be eroded until mid-2017. Inventories will rise more slowly in H2 this year, and could be absorbed by strategic reserve purchases by China, but a meaningful decline is not likely until H2 2017.
Chart: Global Demand Outpacing Supply
…But Demand Growth Will Be Constrained by Slower Economic Growth and Higher Prices
Oil demand growth was particularly strong last year, reaching 1.9 million barrels per day (bpd)—the fastest pace since the post-recession rebound of 2010. U.S. and Chinese demand were particularly buoyant. However, the pace has slowed since Q3 last year.
At a global level, slowing GDP growth in both developed and emerging markets will weigh on oil demand, despite lower (on average) prices. Economic growth is forecast stronger in 2017, but this will likely be accompanied by higher prices as the oil market finally rebalances. Global “oil intensity of economic growth” (barrels per unit of real GDP) is steadily falling, albeit at a lower rate when prices are low, adding further headwinds.
Recent Supply Developments Confirm Non-OPEC Decline, but Iran’s Ramp-Up Has Been Rapid
U.S. output is now 0.5 million bpd lower y/y and the rig count is continuing to drop. Elsewhere outside of OPEC, Russia’s output has been surprisingly strong year-to-date, reaching a new high in March (up by 0.2 million bpd y/y), but unscheduled disruptions have curbed supplies elsewhere (such as Canada and Ghana). We expect non-OPEC output to decline by 0.9 million bpd on average in 2016, of which 0.6 million-0.7 million bpd can be attributed to the U.S. For 2017, while some recovery in U.S. shale is likely given the forecast rising prices, declines of much higher cost output should become more meaningful.
Within OPEC, Iran’s output has recovered more quickly than anticipated and should reach pre-sanctions capacity by mid-year, rather than Q3 as we previously expected. The fundamental impact has so far been masked to an extent by disruptions elsewhere, notably in Libya, Nigeria and Kuwait, where a strike temporarily curbed supplies. With high levels of inventory globally, the price impact of these has been minimal. It is unlikely that Iran will be able to lift production beyond 3.6 million bpd without foreign investment, for which contract terms are still being negotiated.
In Saudi Arabia, the replacement of oil minister Ali Al-Naimi was unsurprising given how he was undermined in April’s joint OPEC/non-OPEC meeting. Where previously we assumed that Saudi output would remain steady y/y in 2016, given recent comments from the new minister, Saudi Aramco chief Khalid Al-Falih, and the deputy crown prince, Mohammed bin Salman, we expect a small increase this year, although we note that some of the reported gains will be to offset declines from maturing fields. Overall OPEC output is likely to rise by around 1 million bpd y/y, including natural gas liquids.
Price Implications: Little Fundamental Support Until H2 2017, but Sentiment Will Rule the Day
Although we expected oil prices to recover from their February lows once risk aversion abated, the recovery has been faster and more extensive than we anticipated, with Brent extending beyond our previous $40/barrel target (Brent), in part due to a weaker dollar as the Fed has become more dovish, but also China stimulus measures that are deemed to benefit commodity demand, including diesel for construction.
Investor sentiment has shifted in favor of oil as general risk appetite has improved—largely due to a better near-term growth outlook for China, and greater capital flows and momentum for emerging markets. Oil fundamentals have moved little over that period, although stronger and more stable growth would imply higher future demand.
Our quarterly forecasts suggest that global inventories will keep rising through to mid-2017. However, the rate of increase in H2 this year is small enough to be absorbed by strategic purchases by China, potentially even leading to a draw on commercial inventories elsewhere, although the scale of recent purchases suggest these might be front-loaded in the early part of the year, taking advantage of low prices.
Given the massive inventory overhang, though, there is unlikely to be a meaningful fundamentally driven rally in prices toward marginal costs ($60-$65/b) until inventories contract more sharply—most likely in H2 2017.
There are still downside risks, most notably from a deterioration in China sentiment if the recent credit-fueled bounce fizzles, but a seasonal decline in U.S. crude inventory should provide some support near term, along with the various supply disruptions.
Beyond Q2, however, still-climbing inventories will likely limit further price gains. We have nudged our forecasts higher to reflect the better outlook for China in particular, and the knock-on impact on sentiment toward commodities generally and the weaker dollar, and expect Brent to average $45/b through to the end of the year, but moving in a $40-$50/b band. Upside risks include an accelerated collapse in U.S. shale (suggesting a more severe collapse in production), improved global economic prospects or a significantly weaker dollar. Downward risks include a sharper increase from Saudi Arabia or a deterioration in the global economy, most likely led by China at this point.