A market awash
Goldman Sachs caused some consternation when it “allowed the possibility” in a September forecast that oil prices could fall to US$20/barrel.
The firm’s forecast was $45/bbl for West Texas Intermediate next year, but it said a price of $20/bbl might be needed to halt oversupply.
Low oil prices are a double-edged sword. They are great for car owners; but unsustainably low prices will be followed sooner or later by a supply squeeze and a price spike.
In a June paper, “Global Implications of Lower Oil Prices”, the International Monetary Fund (IMF) said lower oil prices should translate into higher spending by nonoil producers and stimulate global growth.
But the extent of the effect depended on a number of other factors, including passthrough to consumers and policy responses.
SA’s consumers and businesses have benefited as fuel prices have fallen, but it has also deterred investment in deep-water exploration off the coast as oil majors with limited budgets have tended to focus on more certain and accessible prospects elsewhere.
Rian le Roux, head of economic research at Old Mutual Investment Group, says the lower oil price has had two benefits. The first is in SA’s terms of trade, since the country imports a lot of oil. Though the effects have already been factored in, it is an ongoing benefit.
The second is in the local petrol price, where there have been some cuts, even though government has also used the opportunity to hike petrol taxes.
The full benefit of lower oil prices has already been seen in the petrol price, though there is expected to be another cut of a few cents at the end of this month, unless the rand appreciates sharply, which is unlikely, Le Roux says.
Between 2006 and 2014 the Brent crude spot price averaged above $60/bbl and it peaked in July 2008 at about $145/bbl. Last week Brent crude for December settlement was trading at close to $48/bbl while West Texas Intermediate was close to $45/bbl.
Explaining current weakness in prices, traders cited US oil stocks at above five-year averages; the Organisation of the Petroleum Exporting Countries (Opec) producing above quota; and non-Opec countries, particularly the former Soviet republics, saying they had no plans to cut production.
In its October oil market report the International Energy Agency (IEA) says global demand growth is expected to slow from a peak of 1,8m bbl/day this year towards longterm averages of 1,2m bbl/d next year. This will partly reflect downgrades to the global economic outlook, as the IMF has cut 0,2 percentage points from its projections of global growth this year and next. It will also reflect the ebbing of the initial stimulus prompted by a lower oil price.
Non-Opec production is expected to be reduced next year in response to lower oil prices and spending cuts, the IEA says. Some Opec producers are also tightening spending, particularly Iraq, which has been the world’s biggest source of additional supply. BofA Merrill Lynch says in a global research report that drilling and completion spending by oil companies has dropped 28% since its 2014 peak and is likely to fall another 5% next year.
Most of the fall is in the US and Canada. The biggest decrease in rig count has also been in North America, where it is down 62% from the 2014 peak compared with an 18% decline in the rest of the world.
Edison Investment Research says cutbacks in capex and recovering demand are already evident and will underpin firmer prices. It says the IEA’s forecast production drop in the US for next year is too conservative. At recent lows of $38/bbl for West Texas Intermediate, most US shale oil producers were marginal on a cash basis and on a fully accounted basis the average loss was about $12/bbl.
But most analysts point to several “wild cards” that could keep the oil market in surplus next year and depress prices.
Supply from Iran as it ramps up after the lifting of sanctions could add another 700 000 bbl/day, but the speed at which it is able to increase output will make a difference to market dynamics in 2016, the IEA says.
Edison cites difficulties in predicting Opec’s production rate, the speed of recovery in the Chinese economy and the reaction of US production to lower oil prices. It forecasts that Brent crude could average $54,20/bbl this year, rising to $60/bbl next year and $70/bbl in 2017.
“In the medium term, shale oil development and the Saudis’ desire to head off competition from renewables will probably keep prices well below the highs of 20112014,” it says.
BofA Merrill Lynch says that in the longer term Brent prices need to be $60-$80/bbl to achieve balance in the oil market. “But without a managed Opec price band, oil price volatility will remain a key feature, creating a nightmare scenario for planners of big investment projects,” it says.
The IEA says oil at $50/barrel would help to maintain market balance but “a projected marked slowdown in demand growth next year and the anticipated arrival of additional Iranian barrels — should international sanctions be eased — are likely to keep the market oversupplied through 2016”.