Oil prices “will be meaningfully higher in the second half of 2019,” anticipates Energy Analyst Pavel Molchanov.
April 1, 2019
OPEC and Russia agreed late last year to cut crude production by a collective 1.2 million barrels per day (bpd) for the first half of 2019. Has that happened?
By way of historical background, OPEC generally has a mixed track record for member compliance with its production decisions. The smaller oil producers in the group rarely cut production in accordance with the official pledges. However, as a practical matter, only a handful of OPEC countries truly matter when it comes to managing global oil supply. Saudi Arabia is by far the most important, and for the past two years it has played a very proactive role in this regard.
Based on data from the past several months, we estimate that Saudi production in the first quarter of 2019 is tracking to be nearly 600,000 bpd less than in the fourth quarter of 2018. This alone represents half of the total pledged production cut across all of OPEC and Russia. So, it is clear that Saudi Arabia is serious about propping up oil prices – it is not just lip service!
Beyond Saudi action, let’s also bear in mind that several OPEC countries are experiencing organic production declines even without deliberate curtailments. Case in point: Venezuela. This country has already had the world’s steepest drop in oil production since 2015, for purely domestic reasons. Amid the current political and economic crisis, the national oil company, Petróleos de Venezuela, S.A. (PdVSA), continues to suffer from mismanagement and severe cash flow shortages. Meanwhile, production in Libya and Nigeria is perennially choppy due to recurring violence around oilfields. Looking past this choppiness, the longer-term trend in both countries is downward due to insufficient foreign investment given the hazardous conditions.
The International Maritime Organization (IMO) has set regulations to cut sulfur in fuel used by the marine industry starting in January 2020. How are shipping firms and refiners preparing for this? How do these regulations affect the global oil market?
It is safe to say the oil market, for the time being, is not remotely focused on what will happen in 2020. However, it is important to underscore just how impactful the IMO 2020 policy will be. We estimate it will effectively erase 1.5 million bpd (or 1.5%) of global oil supply, a very meaningful supply reduction. Put another way, this is as much supply impact as what Venezuela has caused over the past four years. Some of this, in fact, will likely be felt toward the end of 2019.
To clarify, the total amount of high-sulfur fuel used in long-distance marine shipping is currently around 4 million bpd. Of this amount, a portion will be processed in newly built units at refineries and another portion will be handled by shipboard scrubbers, which ship owners are in the process of installing. There will be some “cheating,” at the risk of facing sizable fines from regulators, and, as noted earlier, some fuel will simply be rendered unusable.
Another concern, given the dislocations that this may cause, is that some countries could try to back out of the new rules. That, to clarify, is not legally possible because of the binding nature of the underlying treaty known as the International Convention for the Prevention of Pollution from Ships. Moreover, the IMO has made it clear that implementation will not be delayed past January 2020.
What’s your oil price outlook over the next 12 months? What wildcards could derail that outlook?
Oil prices have already bounced back year-to-date from their recent lows but remain well below their 52-week highs. The oil futures curve is relatively flat, indicating minimal upside from current levels over the next five years. We tend to stay away from making short-term (weekly or monthly) commodity calls, but we are of the view that prices will be meaningfully higher in the second half of 2019.
Our forecast for the second half of 2019 is for WTI to average $70 per barrel and Brent $80 per barrel. Looking out to 2020, we think oil will reach cyclical highs, with WTI averaging $93 per barrel and Brent $100 per barrel. To be clear, such prices would be unsustainably high given the adverse impact on global demand (for example, consumers shifting to smaller cars and electric vehicles). That, in fact, is the whole point. We believe that oil prices in 2020 will have to rise to levels that begin to put a damper on demand, in large part because IMO 2020 will create a temporary situation of inadequate supply.
While visibility beyond 2020 is limited, our long-term forecast of $75 per barrel WTI and $80 per barrel Brent reflects a “happy medium” of prices that are high enough to enable the industry to sustain supply growth but not so high as to sharply curtail demand.
As always, there are plenty of wildcards of which we need to be mindful. For example, a sudden spike in the U.S. dollar would, all else being equal, put downward pressure on oil prices. Similarly, a wide-ranging economic slowdown would naturally have a negative effect on demand. On the flip side, there is always the risk of unforeseen supply disruptions, such as what we mentioned earlier vis-à-vis Libya and Nigeria. Finally, geopolitical uncertainty swirling around Iran (U.S. sanctions, etc.) could potentially lead to an even higher-impact disruption.
Read the full April 2019
Investment Strategy Quarterly
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