Oil prices are rising as supply shut ins mount and oil demand seems to be turning a corner. Some oil market analysts even warn that a supply deficit could be on the horizon, one that could balloon in the coming years because of the damage done today.
Demand remains sharply down, but April is widely considered the nadir, even if consumption remains depressed for months to come. Several European countries, along with a number of U.S. states, are easing stay-at-home orders. “While there is still some doubt surrounding the production trends, the market already appears convinced – amid growing economic optimism – that demand and prices will recover rapidly,” Commerzbank wrote in a note on Tuesday.
The supply shut ins will be severe. “Current activity levels in US shale are now so low that the declines will become precipitous without a rebound in completions,” Standard Chartered wrote in a note. The bank sees shale output falling by 2.74 million barrels per day (mb/d) by the end of the year.
But the losses won’t just come from U.S. shale. Worldwide conventional production, which makes up the bulk of total global supply, will also suffer from low prices, deferred maintenance, and shut ins.
The dramatic decline in global oil production, some of which may be permanent, could sow the seeds for the next upcycle. “Lower activity and gradual normalization of demand should drive a more favorable 2021,” Goldman Sachs wrote in a note. The investment bank sees oil prices rallying to $65 per barrel by the end of next year. Related: Is It The Right Time To Buy Into The Oil Price Rally?
Beyond that, some analysts see an even bigger supply/demand mismatch. “Even though the world is currently facing what is arguably the largest oil glut ever recorded, the tables will turn dramatically in coming years,” Rystad Energy said in a report. “The lack of activity and investments currently planned by cost-conscious E&P firms, combined with an inevitable rebound in global oil demand, is set to cause a supply deficit of around 5 million barrels per day (bpd) in 2025.”
Rystad says it sees Brent rising to about $68 per barrel by 2025, but may need to go higher due to the prospect of a supply shortfall.
However, expectations of such a supply shortfall hinge very heavily on a rebound in demand. Rystad said its base case for oil demand is growth to 105 mb/d by 2025, which would require growth of another 5 mb/d in demand over the next five years.
There are numerous reasons why that might be overly optimistic. Given the unfolding recession and a possible great depression, it will take time simply to repair what has been lost in the last few months. Even if governments manage to rescue savaged economies, the lasting scars on aviation and driving, as well as an increase of telework, could prevent a full rebound of oil demand. Combine that with ongoing progress in EVs, and you have a toxic cocktail for oil demand growth.
Even some oil executives are beginning to fear peak demand. “We are looking at a major demand destruction that we don't even know that will come back. So the oil price may come back. But if the volumes are significantly lower, we still have a major dislocation, of course, in our own cash wheel,” Royal Dutch Shell’s CEO van Beurden said.
But Rystad Energy is not the only one predicting a supply shortfall and sharp price rebound. Standard Chartered pointed to the flat futures curve, which it says is too flat at the back end. “We think the market is underestimating the extent of permanent supply damage,” Standard Chartered said. The bank said that longer-dated prices need to rise in order to head off the supply shortage.
By Nick Cunningham of Oilprice.com
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