The oil market is providing little cheer for the bulls these days. At the mercy of an uncertain global outlook, U.S. President Donald Trump’s Twitter account, China-U.S. trade tensions, macroeconomic kerfuffle in Europe and all else in between, Brent – the global proxy oil futures benchmark – remains in technical backwardation six-month out, i.e. the current price is trading at a premium to forward prices.
But examine closely, and you will find that the premium itself has narrowed to less than $2 per barrel. It barely stayed above a dollar on Tuesday (July 2) at the conclusion of the Organization of Petroleum Exporting Countries’ (OPEC) twice-delayed ministers’ meeting – with their 10 non-OPEC Russian-led counterparts to rollover collective output cuts of 1.2 million barrels per day (bpd) – before returning to around $1.50.
And rollover they did, extending the drive to March 2020 in a widely anticipated move on which some commentators had misplaced optimism in. But even intraday trading on Tuesday dashed that optimism. For OPEC provided a “charter of cooperation” on its joint bid to cut output, a poem about the charter, a comparison of US shale output’s imminent “decline” akin to the North Sea, the usual stern exchanges between geopolitical rivals Saudi Arabia and Iran, but precious little by way of how the cartel intends to extract itself from the current production cycle of persistent oversupply despite its cuts.
Consider this – a coterie of 24 global oil producers, including two of the biggest three in the shape of Saudi Arabia and Russia, has announced coordinated output cuts. There is extreme tension in the Middle East. Libyan and Nigerian production remains challenging while Venezuela’s production slump is getting worse by the month. Trump’s sanctions are squeezing Iran.
Yet for all of that, both Brent and West Texas Intermediate (WTI) remain range-bound unable to escape oscillation in the $50-70 per barrel range for most of this year, forward outlook remains one of lower prices. Park the supply-side argument for a minute, even though the U.S. – currently the world’s largest crude oil producer – is pumping 12.3 million bpd, and is tipped to hit 13.4 million bpd by some forecasters.
Let us look at the demand side. Only one of the big five global oil consumers – India – is importing more relative to its 2018 levels, overtaking Japan to become the world’s third-largest crude importer. Of the remaining four, the U.S. is not turning to the global market like it used because of rising domestic production. China’s economic outlook remains cloudy with its post global financial crisis stimulus inspired oil importation levels from 2010-12 unlikely to return.
Just last month, the International Monetary Fund (IMF) cut its forecast for economic growth in China to 6% next year; the lowest since 1990. Meanwhile Japan and South Korea are seeing lower importation levels.Couple that with a growing general level of discomfort about the global economy, and some very real concerns over a possible recession despite equity markets ticking along nicely. The U.S. 30-year yields ended Wednesday (July 3) at 2.47%, their lowest level since October 2016, when the Fed Funds target was 2% lower than it is now.
“The last time the whole U.S. curve was inverted in this way and a recession didn’t follow, was in 1986, when the bond market rally was led by a very sharp fall in oil prices as OPEC output increased by around 25%,” says Kit Juckes, Head of Forex at SocGen.
At present, recession or not, the cartel’s compliance with OPEC/non-OPEC cuts has on occasion run at 163% going by S&P Global Platts data, and June headline production has come in as low as 29.60 million bpd (down 170,000 bpd from May) according to the latest Reuters survey.
That’s the lowest on record since 2014; and gives OPEC less than a third of the global market share for the first time in nearly three decades. All the while, instead of its cuts providing the kind of price support OPEC pines for but never officially acknowledges; U.S. light crude barrels are stepping into the breach taking the relinquished market share.
Initially, most U.S. barrels heading east were for light sweet crude clients lost by Malaysia and Indonesia given their respective production declines. But industry evidence is increasingly pointing to Asian refiners altering their refining complexes to process readily available lighter U.S. crude.
Let’s for argument sake be positive and say there will be no negative quarters in the remainder of 2019, and 2020 sees no recessionary headwinds either. Yet, the oil market is still expected to be in surplus. In a best case scenario, the International Energy Agency (IEA) says global oil demand growth will accelerate to 1.4 million bpd in 2020.
However, that growth rate would be squared against a 2.3 million bpd surge in output, as burgeoning U.S. shale output will be joined by incremental production from Brazil, Norway and Canada. While the projection puts the IEA surplus level at 900,000 bpd, even the most conservative forecast I have seen – by IHS Markit – puts the surplus at least at 800,000 bpd.
OPEC can of course keep cutting, and keep giving up market share. However, at some point something is going to give. All things considered, my prediction is for Brent to average in the $65-70 per barrel range for 2019, closer to the lower end of it; and for the West Texas Intermediate to lurk in the $55-60 per barrel range, again closer to the lower end.
However, all the variables are lining up for an even uglier oil market mauling by the bears in 2020. OPEC’s triumphalism via charters and poems and its discarding of a historical distrust of the Russians won’t prevent that.