Prices to face more downside pressure
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| The price of Brent crude fell to the lowest monthly average in a decade in January, at $30.8 per barrel. Brent price averaged $52 last year and $99 in 2014. Oil supply outpaced demand in the last two years, but the market is expecting a tighter market in 2016. The consensus view is that oil prices will gradually bottom out from January’s low, remaining below last year’s level. US Energy Information Administration forecasts Brent price to average $37.4 per barrel in 2016, reaching $43 by December. Market views are roughly aligned, as Brent futures contracts averaged $35 per barrel for 2016 as of last week. The market may be underestimating future supply and overestimating future demand, which would result in oil prices falling below EIA’s forecast for a third consecutive year. |
The International Monetary Fund projects a recovery in economic growth, from 3.1% YoY in 2015 to 3.4% YoY this year. In our view, global demand will most likely decelerate, to around 2.8%. The IMF expects US growth to rise slightly this year, but recent data suggest otherwise. Investment and consumption are sluggish, the industrial sector is contracting and the labor and property markets are showing early signs of a slowdown.
The IMF expects the euro zone and Japan to accelerate too, but these economies show no signs of strength. February’s PMI figures suggest a deceleration in all three developed markets.
Moreover, China, the world’s largest oil importer, will continue on its deceleration path this year due to its structural rebalancing. EIA and International Energy Agency expect oil demand growth to decelerate slightly from 1.5% YoY in 2015 to 1.3% this year. In our view, these growth estimates are too high.
EIA and IEA estimate oil supply growth to fall from 2.5% YoY in 2015 to 0.5% and 0.3% YoY respectively, driven mainly by a decline in shale output. The low oil price environment has forced US and Canadian companies to cut back on investment and close down rigs. However, the effect is yet to be seen on crude stockpiles, which are still around all-time highs. Upside risks to supply are more evident in other markets such as Iran, Iraq and Libya. Iran and Iraq are producing below their full capacity.
The recent removal of sanctions on Iran and the return of Iraq’s energy industry following years of devastating conflicts is driving a reemergence in their output. Russia, Saudi Arabia and Venezuela, who are producing near record highs, are ready to cap production at current levels, but the deal depends on the participation of Iran and Iraq, which is unlikely to happen.
Moreover, sectarian tensions in the region has complicated the relationship between Saudi Arabia, Iran and Iraq. As such, these countries’ production levels are likely to increase in an uncoordinated manner. A return of Libyan crude to global markets would also raise global supply further. Libya is currently producing 400,000 barrels per day, a quarter of its output before the Arab Spring. However, although a strong comeback is unlikely, slow progress towards the formation of a unity government raises the possibility of a small upturn.
There is no conclusive evidence that the supply gap will narrow this year, and we expect oil prices to remain lower than EIA’s estimates. The oil market rebalancing process will be slow as stronger economic conditions are needed to raise demand. This year, we expect low oil prices to have stronger economic implications on oil-producing and oil-consuming countries. In oil-producing economies such as the GCC, deteriorating fiscal balances will lead to more aggressive measures.
Meanwhile, net oil consumers may feel more positive effects of low oil prices as the lagged price transmission mechanism of the energy supply chain takes effect. On the market front, the impact of oil market developments should begin to subside this year given the discount at which energy companies are trading and economies’ adjustments to current oil conditions.
Prepared by Camille Accad
Economist at Asiya Capital Investments Co
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