Flagging Demand Growth and Resilient Supply Delay Oil Market Rebalancing

 

September 19, 2016 [oil, middle east, saudi arabia, energy market]
Charles Wilson, PhD ; Charles Roth


Oil bulls, beware. Sharp declines in demand growth and stubborn increases in supply mean another deferral of the long-awaited equilibrium in oil market dynamics.

The long-expected rebalancing in oil market supply and demand just got postponed again, as forecasts it would take place in the current quarter and then in the last leg of 2016 are now proving premature. The International Energy Agency (IEA) in its September report pushed the ETA on energy market equilibrium well into next year. An unexpected slump in demand growth has been met with sturdy output. “As a result, supply will continue to outpace demand at least through the first half of next year,” IEA said, adding that global oil inventories in July “smashed” to a new record high of 3.1 billion barrels.

Saudi Arabia

Providing the energy market is driven by economic fundamentals more than major central bank monetary policy, current market dynamics should put a near-term lid on oil prices, which are still less than half their highs from mid-2014, even if they have bounced more than 50% off their February lows.

On the supply side, U.S. onshore breakeven price levels have continued to fall thanks to efficiency gains and deflation in services costs. The combination has allowed some U.S. producers to restart production with oil trading not much below $50 a barrel, retarding the market rebalancing. Top producers in the Organization of Petroleum Exporting Countries (OPEC), namely Saudi Arabia, Kuwait, the United Arab Emirates and Iraq have lately been producing “at or near all-time highs, while Iran’s post-sanctions ramp up has been swift,” said the IEA, an association of advanced country energy consumers. After being overtaken by the U.S. as the world’s top oil producer in 2014, Saudi Arabia in May this year reclaimed the title, as some 460,000 barrels per day (b/d) in higher-cost U.S. shale production was shut in, while Saudi Arabia pumped 400,000 b/d more from its low-cost fields, keeping its total output at a near-record high of 10.6 million b/d in August. Total U.S. crude production in June, the most recent monthly data available, stood at a still substantial 8.7 million b/d, albeit down 190,000 b/d from May and 615,000 b/d from a year earlier. Global oil supply ebbed 300,000 b/d from a year ago to 96.9 million b/d in August.

But demand is the bigger story. The IEA cut 100,000 b/d off its global oil consumption forecast for 2016 and now expects demand growth to amount to 1.3 million b/d. It also shaved 200,000 barrels off its projection for 2017, when it sees consumption growing 1.2 million b/d. A sharp decline in this year’s third-quarter demand growth has driven those downward revisions: consumption growth in the three months ended September 30 totaled 800,000 b/d from the year before, down sharply from 1.6 million b/d in the first quarter and 1.4 million b/d in the second.

Although an excess of refined product inventories contributed to flagging crude oil consumption growth, demand from China, India and Europe softened considerably. Apart from China’s economic rebalancing from investment-led to consumption-driven economic growth, it temporarily shut in industrial production and crimped traffic flows to reduce air pollution ahead of the recent G-20 leaders summit. Extensive summer flooding has also dampened China’s oil consumption. India’s heavy monsoon rains, though an economic relief after a few previous years of subpar rains, also undercut the country’s third-quarter oil consumption. Oil demand from Europe’s industrial sector has proved more anemic than expected.

Oil market bulls shouldn’t bet the farm that the oil price overhangs will lift anytime soon. Although the IEA is looking for supply and demand to balance in the fourth quarter of next year, the world in the interim will add another 150 million to 200 million barrels of oil to current inventories. The rebalance remains in the hands of the producers—in particular U.S. onshore producers and Saudi Arabia. While U.S. production has declined nearly 1 million b/d since the peak in 2015, and Nigeria’s output recently fell around 400,000 b/d from the year before, the declines have been largely offset by increasing production from Saudi Arabia and other OPEC members. Saudi Arabia is on a path to increase production about 600,000 b/d in the last quarter of the year from end 2015. Iran, meanwhile, increased its output 750,000 b/d in August from the year-earlier month. According to the IEA, Saudi Arabia can push sustainable production to 12.2 million b/d, which implies the ability to bring on another 1.6 million b/d without too much effort. This remains in dispute. What isn’t debatable is that the worst of the U.S. declines are behind us, as U.S. rig count is now rebounding and global oil inventories continue to grow.

This is not good for oil prices or oil company equities, which are pricing in oil at $60 to $75 per barrel. Downward earnings revisions for oil services companies are also likely under this latest shift to a “lower-for-longer” oil price outlook.

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