Energy Monitor August – Further fall in oil prices on oversupply concerns

by: Hans van Cleef

  • Oil price hits lowest level in months as oversupply worsens…
  • while demand growth disappoints and the dollar further appreciates
  • Brent Oil average price forecast for 2016 adjusted downwards to USD 65/barrel


Oversupply scaled up yet again…

The oil price slide appears to have accelerated over the past few days. The market seems to be in thrall to the negative drivers. Oversupply has dogged the oil market for some time (except for two quarters in 2012), but recently gathered further pace. Saudi Arabia and Iraq have again stepped up production, bringing OPEC’s current output to nearly 32 million barrels per day, significantly more than OPEC’s agreed quota of 30 million barrels per day and required demand for OPEC oil of about 29 million barrels per day. What is more, the recent deal between Iran and the West means there is potentially far more oil in the pipeline.

On top of this, US production growth shows no signs of abating. The drop in the number of drilling rigs appears to have stopped, the reason being that the backlog of various oil fields (found, but not yet in exploitation) has been reduced, indicating that more found oil fields have now come on stream. This has increased the need to search for new fields. The big question, however, is how long businesses can continue financing exploration and development activities at the current rock-bottom oil prices.

… While demand for oil is disappointing

To explain the price effects, the huge supply of oil needs to be seen in conjunction with disappointing demand from e.g. China (Purchasing Managers Index (PMI) below 50 for five months now), flat demand in Europe and only slightly rising demand in the US (both due to economic recovery combined with efficiency gains). Added to this, we expect the dollar to make further major advances versus the euro (towards parity later this year). The strong rise of the dollar over the past months is putting extra pressure on the prices of dollar-traded commodities (including oil). As a result, it is difficult to see any upward potential for oil prices in the near term. In fact, if the negative sentiment persists – or even worsens following new data – the price could retreat even further. A test of January’s lows can therefore certainly not be ruled out. This shows that market forces are operating efficiently at the moment (one-sided focus on negative drivers).

Thad said, we maintain our forecast of an average oil price of USD 60/barrel for Brent oil in 2015 (Table 1) and a WTI price that is USD 5/barrel lower. For next year though, we lowered our forecast for oil prices significantly. We still foresee a recovery with the market returning to equilibrium (with lower (over)supply, mainly due to marginally higher demand and a weaker dollar) in the course of 2016. However, the oversupply will remain larger than previously expected as the OPEC producers above its’ quota, and also US crude production will remain elevated. This equilibrium will therefore not be seen before the second half of the year. We expect an average price of USD 65/barrel for Brent oil in 2016. This downward revision is mainly supply driven. The risks of disappointing demand still exists. We will continue to keep a close eye on the market and make a (downward) adjustment to our outlook as soon as the need arises.