2019 starts with a high degree of uncertainty over the path of the global economy. Leading economic indicators point to a downturn and US trade policy has halted the former direction of travel towards more globalised free trade.
The Chinese/US trade war rumbles on, the EU and the UK stand on the precipice of a ‘no deal’ Brexit divorce, which threatens the economic prospects of both. The era of quantitative easing appears to be over and interest rates are on the rise. All of the world’s major economies face a tougher economic outlook.
Given the close correlation between global GDP and oil demand, oil market participants have become bearish, calculating that muted oil demand growth means OPEC must do more than it currently intends to balance supply and demand.
At its last meeting in December, OPEC and its non-OPEC partners agreed to curb output by 1.2 million b/d for the first six months of this year. Given rising US output and the deepening gloom overhanging the global economy this was regarded by the market as inadequate, causing oil prices to plummet from just over $60/bbl in mid-December into the low $50s towards year’s end.
However, despite the prevailing pessimism, a downturn is not yet established fact, nor is a significant supply surplus in the oil market throughout 2019.
Less growth not no growth
The IMF, in its October World Economic Outlook, predicted global GDP growth of 3.7%, the same rate as in 2017 and 2016, although the rate of expansion in advanced economies is expected to slow. The outlook into the early 2020s remains just above 3.5%, which, while unspectacular, is relatively robust.
Interest rates are still at historically low levels. The European Central Bank (ECB) expects eurozone inflation to remain just below 2% in 2019 in line with the bank’s target. Considering the uncertainty surrounding Brexit, the ECB is unlikely to make aggressive interest rates changes unless there is a substantial overshoot on this forecast.
The US Federal Reserve signalled in 2018 that interest rates were likely to rise further in 2019, but this outlook was predicated on a strong US economy, and the Fed’s targets are less bound to inflation than the ECB’s. If interest rates are increased further, they are unlikely to go up far and fast, particularly amid signs that US growth is slowing.
Most economic forecasts now put global GDP growth slightly lower than the IMF’s October outlook, between 3.0-3.7%, but assume no major change in US interest rates as expectations about US GDP growth are revised downward.
At present, conditions certainly imply weaker oil demand than in the last four years, but no collapse. OPEC predicts demand growth of 1.29 million b/d in 2019, the International Energy Agency 1.4 million b/d and the US Energy Information Administration 1.52 million b/d.
It’s clear that whatever the relative pain, the Sino-US trade war is hurting both sides. In December, a deal was reached to delay the imposition of further tariffs and Chinese and US officials started new talks January 4. China has also announced stimulus measures for its banking sector aimed at increasing lending to boost domestic investment.
Although it’s difficult to gauge the likelihood of either, a reduction in trade tensions between China and the US combined with the avoidance of a no-deal Brexit could change the economic outlook for 2019, and thus the demand outlook for oil, quite radically and fairly quickly.
The supply side is no less uncertain. Saudi Arabia appears to have followed through on promises to cut oil production in December, despite the new OPEC/non-OPEC agreement only coming into effect from January.
According to a Reuters survey, OPEC output fell by 460,000 b/d in December, Saudi Arabia accounting for 400,000 b/d. Riyadh appears once again to be willing to over comply, potentially supported by the UAE and Kuwait, suggesting that OPEC as a whole may deliver more than it has promised and sooner.
In the US, shale production remains on the up and up, with net gains from shale production expected to grow into January and the number of drilled but uncompleted wells (DUCs) still increasing. However, the business activity index of the Dallas Fed Energy Survey showed a huge drop for the fourth quarter to suggest only a marginal expansion in energy sector activity from the third quarter.
Brent crude is bumping along in the mid-$50s, but US marker West Texas Intermediate is a good $9/bbl lower putting it in the high-$40s, a sea change from the first 10 months of last year and not a price level that will sustain the expansion of 2018. If the fourth-quarter pause continues into the first-quarter 2019, the EIA’s forecast of a rise in US crude production from an average 10.9 million b/d in 2018 to 12.1 million in 2019 will almost certainly be revised down.
Rising spare capacity in Saudi Arabia and in the form of US DUCs also provides scope for Washington to harden its sanctions policy on Iran. Waivers were granted to importers of Iranian crude largely owing to US government concern over the impact of rising pump prices ahead of mid-term elections in the US. That electoral pressure has dissipated and the impact of a tougher line on sanctions would be to the benefit of both US crude producers and US ally Saudi Arabia.
There are in effect two short-term corrective factors in the oil market – OPEC/non-OPEC producers’ willingness to agree and implement cuts and US shale production. While the actions of one counteract the actions of the other, both are price responsive, which results in an imperfect, jerky synchronicity. The production curbing actions of both could come together just in time for the 2019 US driving season, lifting some of the current oil market gloom.