Oil demand continues to soften, which could result in a supply surplus in the second half of this year.
In its latest Short-Term Energy Outlook, the EIA downgraded its forecast for global oil demand growth to just 1.1 million barrels per day (mb/d) this year, down from the 1.2 mb/d the agency forecasted last month and from 1.4 mb/d in May.
The “increasingly weak outlook” for demand could upend global balances. In June, the EIA thought that global inventories would decline by a rather significant 0.3 mb/d in 2019, as OPEC+ cuts and still robust consumption tightened up the oil market.
What a difference a month makes. The souring economic picture now means that inventories could actually increase by 0.1 mb/d, the agency said in its latest report. In other words, even with the OPEC+ cuts extended, the oil market could remain in a state of surplus throughout this year and next.
The IEA and OPEC report their versions of the monthly oil market report later this week, both of which could contain some downward revisions in demand. “While the IEA reduced its 2019 demand growth forecast by 120kb/d to 1.18mb/d in its June report, it increased its forecast for H2-2019 y/y growth by 130kb/d to 1.64mb/d,” Standard Chartered wrote in a recent report. “[W]e expect to see that forecast scaled back in coming months.”
The top energy forecasters may also be a bit too optimistic on 2020 figures as well. “The IEA expects US oil demand growth to accelerate to 350kb/d in 2020 from 180kb/d in 2019; we think this runs counter to the trend of most forecasts for the US economy,” Standard Chartered added.
But, the supply side of the equation is also bearish. The growth of U.S. oil production alone could exceed the increase in total worldwide consumption. While the world will consume an additional 1.1 mb/d this year, the U.S. could add 1.4 mb/d, with most of the growth coming from the Permian. Texas and New Mexico will add more barrels to the global market than all of the world’s consumers can handle. Related: OPEC Wants Quick Resolution To Tensions Between US And Iran, Venezuela
That is an impressive feat for shale drillers, but as has been exhaustively chronicled in recent months and years, record production doesn’t necessarily add up to profits for the industry.
In fact, despite the lofty projections for shale growth by the EIA, the industry is facing financial pressure with oil prices at their current levels. The rig count continues to fall. Standard Chartered noted that there has been a pronounced drop off in drilling activity in Oklahoma, where companies are growing disillusioned with the SCOOP and STACK plays. The shale plays were once thought of as sort of the “next Permian,” but drilling results have proved disappointing. The rock formations have turned out to be more complex than previously thought, the output less than hoped for, and as a result, the financial returns have been poor.
“The [year-on-year] fall in Oklahoma’s oil drilling is 41 (31.1%), which together with the 54 rigs y/y in fall Texas (11.1%) more than fully accounts for the 75 rigs fall in total US oil drilling,” Standard Chartered pointed out.
The next near-term catalyst for the oil market will be decisions made by the U.S. Federal Reserve. Evidence of a mounting economic slowdown are widely expected to result in interest rate cuts, although how far the central bank will roll back recent hikes remains to be seen. On Wednesday and Thursday, Fed Chairman Jerome Powell will testify before Congress, which will likely offer more clues into the bank’s plans. Related: China’s Fight Against Pollution To Generate Billions In Extra Solar Income
A rate cut could provide a jolt to crude prices, both because lower interest rates are likely to extend the economic expansion and because lower rates tend to drag down the dollar, which would make crude more affordable to many people around the globe. However, with all of that said, a rate cut is already somewhat factored into oil prices, which would reduce the impact when the Fed announces the move.
One uncertainty is the extent to which the latest strong jobs report undercuts the rationale for rate cuts. The dollar gained strength after the U.S. government reported unexpectedly strong employment growth in June, suggesting that traders began to price in smaller interest rate cuts. “In the bigger picture, oil prices are stuck between the positive impact of the trade war ceasefire and OPEC+ cuts, and the negative impact of a higher dollar and weak global macroeconomic data,” Jens Naervig Pedersen, a senior analyst at Danske Bank A/S, told Bloomberg.
By Nick Cunningham of Oilprice.com
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Still, its effect on China’s thirst for oil would be limited because of the size of its economy which is 28% bigger than the United States’ based on purchasing power parity (PPP) and far more integrated into the global trade system than America’s thanks to China’s Belt & Road Initiative (BRI). That is why China’s economy can take more punishment than America’s.
However, oil prices have been getting some support from one quarter. China which alone accounts for two thirds of global oil demand growth has been buying increasing volumes of oil to build its strategic petroleum reserve (SPR) to 90 days of consumption amounting at current daily consumption of 13.525 million barrels a day (mbd) to 1217.25 million barrels of oil taking advantage of relatively low oil prices to build up its SPR to full capacity.
Still, a global oil demand growth of 1.1 mbd could put a floor under oil prices until a deal ending the trade war is reached though I rate the chances of a deal before the end of this year below 50%.
For these reasons, oil prices could continue to range from $60-$65 a barrel unless there is a serious escalation of tension in the Gulf leading to military clashes or until somebody advises President Trump that without a trade deal with China soon he could jeopardize his chances of winning the 2020 presidential elections.
The claim by the author that US shale oil production could add 1.4 mbd to the global oil market is more of a hype. Many pioneers of the industry and numerous authoritative sources are projecting a major slowdown in shale oil production.
Due to geological, financial and logistical factors, US shale oil production is starting to slowdown. This is inevitable given the steep depletion decline in US shale oil wells estimated at 70%-90% in the first year of production, declining well productivity, rising cost of production and declining acreage to allow for growth.
After having grown by 1.54 mbd from 9.36 mbd in 2017 to 10.9 mbd in 2018 according to the authoritative 2018 OPEC Annual Statistical Bulletin, US oil production is projected to decline to 10-11 mbd in 2019 and 10 mbd or even less in 2020. US production growth is set to decelerate sharply from 2020 onwards.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London