After repeated downward revisions to demand, and ongoing supply increases, the oil market is facing a growing surplus next year.
OPEC+ only recently extended its production cut agreement, stretching it out through the first quarter of 2020. But even as producers agreed to keep supply offline, OPEC and its partners are staring down a swelling glut that will prove difficult to manage. The group has few choices at its disposal, most of which are unpalatable.
Slowing demand
Oil demand growth has slowed dramatically this year. In its latest Oil Market Report, the International Energy Agency (IEA) cut its demand growth forecast to 1.1 million barrels per day (Mb/d) for 2019, the latest in a series of downgrades. But even that figure might prove to be overly optimistic, as it hinges on a spectacular rebound in consumption in the second half of the year.
The IEA said that demand was “very sluggish” in the first six months of 2019, growing by only 520,000 barrels per day (b/d) from a year earlier, the slowest pace since the financial crisis in 2008. “There is growing evidence of an economic slowdown with many large economies reporting weak gross domestic product (GDP) growth in 1H19 linked to lower trade and manufacturing output,” the IEA said.
If demand growth is to hit 1.1 Mb/d this year, as the IEA still believes, consumption will need to dramatically accelerate. The IEA predicts demand will hit 1.2 Mb/d in the third quarter, followed by a whopping 1.9 Mb/d in the fourth quarter. Such an impressive turnaround is theoretically within the realm of possibility, but a variety of indicators point to economic trouble, not healthy growth. For instance, auto sales in India, China and Germany are suffering from double-digit contraction, big red flags that raise questions about a potential economic recession. China’s auto market has seen 13 straight months of falling sales.
The odds that demand growth falls below 1 Mb/d this year are rising by the day. The head of Vitol Group said that oil demand may only grow by a paltry 650,000 b/d this year. The IEA will be under the microscope in coming months as analysts and investors watch for further cuts to its demand forecast.
Surplus set to grow
Even as demand slows, the IEA sees supply growing by 1.9 Mb/d this year and by another 2.2 Mb/d next year. In other words, supply continues to significantly outpace demand growth. Brent crude is already struggling to stay above $60 per barrel, but the surplus may only balloon next year.
That raises tough questions for OPEC+ as it seeks to balance the market and keep oil prices from falling. Earlier this month, prices rebounded when Bloomberg reported that Saudi officials were considering more extreme action to prop up the market. A Saudi official said that the “kingdom won’t tolerate a continued slide in prices,” although little else was spelled out.
Saudi Arabia and its OPEC+ partners are in a particularly tricky spot, largely at the mercy of the deteriorating economy
Saudi Arabia has a history of jawboning the market, talking up or down oil prices with hints and clues about future action. But while the strategy has always had its limits, Saudi Arabia and its OPEC+ partners are in a particularly tricky spot, largely at the mercy of the deteriorating economy.
With the global supply surplus expected to grow worse in 2020, OPEC+ will face tough set of decisions when its current deal expires. It could extend the current cuts, and risk a worsening glut and falling prices, or it could cut deeper, shouldering a deeper burden of production curtailments in the hopes of rescuing prices. Neither choice is appealing.
“Unlike the price crises of 2014-15 and late 2018, the current crisis is not being driven by any prompt market imbalance,” Standard Chartered wrote in a recent note. Back then, swelling supplies could be counteracted with temporary production cuts. But this time, the market “is being driven by fears of a more extreme outcome: a sharp compression in global trade and GDP, accompanied by falls in global oil demand,” Standard Chartered said.
OPEC+ may feel compelled to take more decisive action, such as cutting output deeper, but it may not work because the deterioration in oil market conditions are “the result of policy developments in Washington and Beijing,” Standard Chartered said.
“We think that the oil policy options for key producers are limited, for the moment,” the investment bank said. They “may be best advised to stay on the sidelines, for now.”
Saudi Aramco wants to launch its public offering next year, which likely necessitates higher prices
There are a few other wrinkles to consider. After several false starts, Saudi Aramco wants to launch its public offering next year, which likely necessitates higher prices. That may push Saudi Arabia to push OPEC+ to consider another round of cuts because the lofty valuation that Aramco desires depends on higher prices.
Meanwhile, U.S. shale is facing financial stress, and production growth is finally slowing after years of rapid expansion, with year-on-year production gains in the Permian expected to dip to 728,000 b/d in August 2019, down from 1.12 Mb/d in August 2018. Spending cuts and more modest drilling programs could yet slow production further, which would make OPEC’s task a bit easier next year.
Ultimately, however, the most pivotal factor determining oil market balances is the health of the global economy. The U.S.-China trade war has been a huge drag on the global economy, and many economists now fear that a recession is drawing near. If that occurs, OPEC+ will find it increasingly difficult and painful to put a floor beneath prices.
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