In its June oil market report, the International Energy Agency (IEA) revised downward its global oil demand forecast for 2019 for the second consecutive month, this time by 100,000 b/d to 1.2 million b/d. It said that in first-quarter 2019, global oil demand had risen by just 250,000 b/d – “the lowest annual growth registered since 4Q11, when the price of Brent crude oil averaged $109/bbl.”
The agency also revised downward its second-quarter 2019 oil demand growth estimate by 300,000 b/d, reflecting lower than expected Chinese demand of 230,000 b/d in April, “owing to significant downgrades for diesel and LPG.”
These estimates incorporated new GDP forecasts from the OECD published in May. The OECD estimates a drop in global GDP growth this year to 3.2% from 3.5% last year and 3.7% in 2017. Growth in 2019 and 2020 (3.4%) will be “well below the growth rates seen over the past three decades, or even in 2017-18.”
The OECD’s assessment of the global economy was gloomy, pointing to the impact of trade tensions on business investment and trade growth, both of which have fallen sharply. Manufacturing production has contracted, and while the services sector has held up well, the OECD warned that it is “unlikely that they [services] decouple for long from manufacturing.”
Trade war impact
The OECD’s weak growth outlook is based on no further deterioration in trade relations but did not include the additional tariffs announced in May by the US which have yet to be implemented. China also imposed higher tariffs on $60 billion worth of US imports into China from June 1.
The OECD estimates slightly higher GDP growth in 2020 and the IEA higher oil demand growth, in part a product of a demand boost from lower oil prices.
However, if the US imposes tariffs on the $300 billion of untaxed Chinese imports as threatened after the G20 talks at the end of June, then trade will take a further hit. In a worst-case scenario, the IEA estimates that global oil demand could be reduced by up to 350,000 b/d one to two years after the new measures are imposed, compared with its base case.
There is a real risk that downward revisions in GDP growth and oil demand remain behind the curve and have yet to hit bottom. This possibility would become a near certainty if the US goes ahead with additional tariffs on Chinese imports.
OPEC has delayed its next meeting until after the G20 summit, where US President Donald Trump and Chinese President Xi Jinping are expected to meet. Trade negotiations are slated to resume within days of that meeting.
The hope is that the imposition of the additional US tariffs will, at the least, be suspended while the talks continue and potentially be avoided altogether if a breakthrough occurs subsequently. But if there is one oil market theme prevalent in 2019, it is a persistently over-optimistic view of how the US/China trade war will evolve.
That optimism is founded on the basis that the more obvious the economic fallout from the trade war becomes, the bigger the incentive to find a resolution. The G20 will make clear the threat to the world economy, and the resumption of US/China trade talks will produce some positive signals.
However, some of the issues at the heart of the negotiations are likely to defy short-term resolution. Another break down in the talks is a real possibility. OPEC’s meeting – delayed to July 1 – could thus take place in a potentially false afterglow from the G20.
A slowing world economy hits OPEC right in the fundamentals. In a high-growth scenario, OPEC can hope at least to share in the market expansion, but in a low-growth scenario, it may not only fail to gain a portion of new demand but have to give up market share to expanding non-OPEC supply. This is set to be particularly strong this year and next, not just as a result of short-cycle US shale oil, but longer-cycle non-OPEC investment outside of the US.
Although war and conflict risk – US/Iran, Libya, Venezuela – remains a major and uncertain counterbalancing factor, OPEC may have to do more than maintain its current curbs on output. It may have to recalibrate its price expectations more fundamentally.
Following downturns, US shale oil starts to resuscitate around $50/b WTI and grows wings at $60/b, a price level with which oil companies active in Canada, Norway, Brazil and Guyana now also feel comfortable, following the sharp reductions in upstream costs which followed the collapse of oil prices at the end of 2014.
OPEC’s target should, therefore, be no more than $60/b Brent to stabilize run-away US oil production growth and stimulate demand. Aiming higher means giving up value via lower market share.
Longer term, the organisation, currently riven by the Saudi/Iranian rivalry, needs to maintain its market share to accommodate Iraqi growth ambitions, maintain output volumes in the Arab Gulf Kingdoms and eventually adapt to a rehabilitated Iran and a recovering Venezuela, all within the context of at the least slowing oil demand growth, if not peak oil demand.