Crude prices likely to rebound in H2 2015
Global oil balances will increase in the first quarter of 2015 as oil demand remains subdued but oil supply continues to expand from the US, Russia and Iraq. All of this will maintain pressure on oil prices in the first quarter, according to Jadwa Investment
“Beyond Q1 2015, we see prices recovering, with a sharper rebound in H2 2015,” said the Jadwa researchers in their Quarterly Oil Market Update (Q4 2014).
Saudi Arabia’s strategy is clearly to maintain market share in key export markets and as a result we see production falling only slightly in the next two years, said the report
“We project full year average production in 2015 at 9.6 mbpd, declining to 9.4 mbpd in 2016,” said the report.
The following are excerpts from the report:
Brent prices dropped 25 percent in Q4 2014, to $77 per barrel, quarteron-quarter, which pushed full year 2014 prices to an average of $99.4 per barrel, below our forecasted price of $102.
We foresee current low oil prices persisting into the Q1 2015 as surpluses in global oil balances peak due to no cuts from OPEC, the lower price environment taking time to affect non-OPEC supplies, and demand remaining subdued.
Despite prices dropping below $50 per barrel at the beginning of January, we see prices recovering to $79 per barrel for 2015 as whole.
We see prices being support by i) stockpiling of crude ii) the occurrence of contango resulting in some surplus leaving the market iii) quicker than projected reduction in US shale oil and iv) a pickup in demand due to improvements in global economic growth.
It has been a long term energy strategy of the Chinese government
to buy crude for stocks at a time when prices are low. China currently has around 31 days’ worth of crude imports in stock, but has targeted around 100 days by 2020, which would represent around a further 700 million barrels, or 0.4 mbpd. India too has stated that it needs to build up strategic crude stocks with 7.3 million barrels of additions outlined by the government for 2015. We therefore expect the prevalence of lower prices in 2015 leading to China and India accelerating purchases of crude stock and supporting oil demand, to some extent.
Oil prices slipped into contango in early January, that is, a barrel of oil cost more for delivery in the future when compared for delivery immediately.
Currently, Brent for delivery in October is trading at a premium of $8.87 per barrel compared with February (Figure 13). Many industry analysts believe that $6.5 per barrel is the point at which storing of crude to sell at a future date by traders becomes profitable.
Some of the world’s largest oil traders have started to hire supertankers that are capable of storing crude at sea.
The last time the oil market moved into contango was immediately after the financial crisis, in 2008 and 2009, where traders stored around 100 million barrels at sea. The level of stored crude is likely to be much more now considering that US commercial oil storage has expanded by 30 percent since 2010. We therefore see oil market contango preventing further downward pressure on prices, in the least, in Q1 2015 and throughout 2015 as traders start buying physical crude to stockpile.
The US shale oil industry is made up of numerous small and medium sized companies, most of which have taken advantage of the low interest environment and higher risk appetite in recent years in the US to obtain financing via the high yield corporate bond market. As the price of oil has dropped the fear of defaults has risen resulting in a dramatic sell-off, and drop in value, in these bonds.
The consequence for small and medium sized energy companies is that new financing will be very limited and expensive which, in turn, will increase break even costs for shale oil production, ultimately impact drilling in unconventional fields.
Secondly, as we pointed out in our report titled The Outlook for Unconventional Oil & Gas Production (published December 2013), decline curves (in production) for typical shale wells, such as in the Bakken, are steep, with first year declines in production around 69 percent and overall decline in the first five years around 94 percent.
The consequence of such steep decline curves is that more and more wells need to be dug to sustain, let alone increase, production, but as financing costs increase and oil prices remain low; this will be very difficult to achieve.
It is important to highlight though that in the short term, as we have been witnessing, US oil production will continue rising, since oil is still being produced from a backlog of wells from drilling that occurred during 2014.
As these wells are cleared production will plateau, in our view as early as Q2 2015, and then fall dramatically.
Brent prices dropped 25% in Q4 2014, to $77 per barrel, quarteron-quarter, which pushed full year 2014 prices to an average of $99.4 per barrel.
We expect economic growth to improve gradually throughout 2015, with H2 2015 seeing an acceleration in growth. The main driver of the global economy, and indeed oil demand, will be the US but global economic growth will also be assisted by the prevalence of lower oil prices in 2015.
Lower prices will decrease import costs for non-oil producing countries and add disposable income for consumers. A $20 per barrel decline in oil prices is estimated to bring about 0.25 percent increase in the global economy’s GDP over a year, which in turn, will spur demand for oil.
We do note that there is a downside risk to the forecasted $79 per barrel especially so in an oil market defined by intense competition. More specifically we see downside risks rooted to slower than predicted Eurozone, Japanese and Chinese GDP growth.
Finally, there is the possibility that US shale oil supply does not respond to lower prices until after H2 2015, resulting in a steeper surplus in global balances than forecasted by OPEC.