Energy Monitor – Oil price rally continues

by: Hans van Cleef

  • Oil price forecasts revised higher for 2018 and 2019
  • Global demand will continue to increase
  • OPEC will continue to mainly steer on market share
161117-Energy-Monitor-Nov.pdf (273 KB)

Oil price forecasts revised higher

In our previous Energy Monitor we already pointed at the upside risks for oil prices. We even decided to raise our oil price forecasts for 2018 and 2019. Oversupply dominated the direction of oil prices for years. However, recently the market has improved resulting in an equilibrium between supply and demand. In fact, the market may even overreact in times when fear for possible oil shortages could push oil prices higher. It is likely that the oil market will from time to time fear supply shortages resulting in higher prices and a change of the curve. The global demand for oil will continue to rise in the coming years in our view. The main driver for this is economic growth in emerging countries, mainly India and China. Higher oil prices give oil producers the much needed breathing space.

The production cut agreement between some OPEC and non-OPEC oil producers led to a drop in inventories and to a recovery of oil prices. It is now up to the ‘swing producers’ to keep oil supply in balance with the rise in demand. This is possible if US shale producers accept a moderate growth path for its oil production. In other words, the market share between OPEC and non-OPEC should remain intact.

We also see that geopolitical tensions start to have a more considerable impact on oil prices again. Although the overall effect is still small, escalation of tensions between Iran and Saudi Arabia or Iran and the US could lead to a lower oil production. This would support oil prices. The ambition of the Kurds to have an own state has resulted in higher geopolitical tensions in the region. These tensions could have a negative impact on the oil production in these Turkish and Iraqi regions.

In the course of 2018 we expect a continuation of the oil price rally towards USD 75/bbl in our base case scenario. This rally could continue into 2019 before oil prices may start to stabilize due to the rise in supply. West Texas Intermediate (WTI) will probably move in tandem with Brent. WTI could appreciate to USD 70/bbl in 2018.

Global oil demand continues to grow

Ongoing growth in global oil demand will form the basis to which global supply must adjust. According to the International Energy  Agency (IEA) global oil demand will grow by 1.3-1.5 mb/d in 2018 and 2019. Analysts of the OPEC raised their expectations for the so called ‘call on OPEC’ and have proved to be more optimistic that the IEA.

The rise in demand will mainly come from emerging Asia. Especially oil demand from India will rise significantly. Also oil imports by China will continue to increase, especially now the local oil production fell under pressure. As showed in the graph below China’s oil imports eased slightly but still growths with more than 10% per year, even despite the moderate growth path the Chinese government attempts to adopt.

The Chinese government attempts to fight air pollution by supporting investments in renewable energy and to discourage the usage of fossil fuels. Nevertheless, it proves to be a big challenge to stimulate economic growth without raising the use of energy, including the usage of coal, gas and oil.

Supply uncertainty results in high volatility

Since 2014, supply-driven events mainly drove oil prices. When we take a closer look to supply, we can indicate three important focus areas: 1) OPEC; 2) US (shale-)oil; and 3) others.

  1. On 30 November the OPEC will meet in Vienna. Also Russia – as the most important non-OPEC member – will join this event. Most likely, OPEC will clarify if it will extend the production cut agreement after March 2018, and what the conditions will be. Without such an agreement oversupply will probably return putting pressure on oil prices.The current production cut agreement (cut of 1.2 mb/d by OPEC and 0.6 mb/d by non-OPEC oil producers) led to a normalisation of the supply/demand balance and a drop in crude inventories. Still, not only the extension of the production cut agreement will be in focus, but also the level of compliance afterwards. As soon as oil prices continue to rally, it is likely that the risk increases that some producers (like Iraq, Venezuela, Nigeria and/or Russia) will not stick to their targets and start to producer more anyway.
  2. Expectations for US shale oil production are high. As shown in the graph above, the development of US drilling rigs lag the WTI price trend behind by a four to five months. Recent oil price recovery will therefore most likely be followed by a rise in US drilling rigs in the coming weeks. The IEA expects a rise of crude production by the non-OPEC producers of 1.4 mb/d (including US shale oil). On the other hand, OPEC expects a rise of non-OPEC oil production by 0.85 mb/d, including US shale oil. The main reason why we believe that US shale oil will disappoint somewhat is a rise in cost of: labour, infrastructure and financing. Taking into account the expected rise in global demand for oil, in combination with a lack of investments in long-term oil projects (outside OPEC and US), a rise of US shale oil production is needed to prevent significant shortages in the longer term. The main question remains whether the market share of OPEC will remain intact when US crude production increases. That will for OPEC – and mainly Saudi Arabia – be the crucial argument to decide whether it will a) stick to its current strategy, or b) shift its attention towards regaining market share by opening the oil tap again. Whether this will happen is hard to predict. Still, this risk continues to hang over the market and may have a dramatic (negative) impact on oil prices.
  3. Finally, we look at the other oil production. The major oil companies are still very conservative in investing in new exploration projects. The number of these projects is still significantly lower than just before the price collapse in 2014. This can partly be explained by the fact that production costs decreased. As a result of efficiency, cost of exploration dropped. These costs will not increase again at the moment that oil prices rise further. Even now oil prices has risen, investors will probably remain reluctant with investing in new long-term risky projects. The fear for a repetition of the steep 2014 price fall, when OPEC increased oil production to gain market share and therefore added severe pressure on oil prices, is still present. And even if investments in these kind of projects are increased, it would still take a long time before the infrastructure is in place, and production will actually start to contribute to the global numbers.