Why oil price recovery won’t happen yet

Posted in Blog

By Mike Eggleton, Senior Market Analyst

Recent price trend

Between August 2014 and January 2015, the spot price for Brent crude oil fell 57%. A modest rebound in prices in the first half of 2015 then provided the market with some false hopes of a price recovery. But a combination of persistent over-supply and growing concerns about the strength of global consumption have weighed down on oil prices ever since.

That’s not to say that oil prices are stable.oil price

Sentiment, rather than any fundamental changes in the oil market, has made oil prices quite volatile in recent months.

Like many asset prices, oil was hit this January by fears that China’s economy faced a “hard landing,” which would depress global oil demand. Oil prices fell below US$30 pb.

Hopes that OPEC and Russia would agree coordinated oil production cuts then sparked a rally in prices.

More recently, an IEA (International Energy Agency) prediction that 2016 would see the biggest annual cut in production by non-OPEC nations in 25 years provided a further cause for optimism. Prices rose in response, reaching their highest level in five months. Improving economic data has kept oil prices on an upward path, bringing them very close to US$50 pb.

Energy traders expect a better balance between oil supply and demand to emerge, and this may at least place a “floor” under crude prices. But this is unlikely to mark the start of a sustained recovery.

Without any concerted effort to cut production, stock accumulation will continue, as many of the world’s markets are already well-supplied. There needs to be an underlying tightening of supply in the global oil market to deliver a more sustainable rally in oil prices. But this seems unlikely:

  • While it’s true that non-OPEC producers like Brazil, Canada and the U.S. have cut production, OPEC’s leading producer, Saudi Arabia, is unlikely to do the same for fear of losing market share to Iran and Iraq.
  • Iraq is ramping up production, while Iran’s return to the global market will add a significant new source of supply in 2016.
  • Oil companies often find the costs of shutting down existing production exceed the losses from continuing to pump oil at today’s low prices.
  • Some countries are actually ramping up production to offset the revenue lost to low prices.

In April, major producers failed yet again to agree a production freeze. Political tensions with regional rival Saudi Arabia ensure Iran’s absence from talks. A deal to cut production still seems some way off.

Oil price outlook

oil price forecastUnder these circumstances, a rapid recovery in oil prices any time soon is unlikely. And there’s even a risk that oil prices could retreat once again.

In April, the U.S. Energy Information Administration (EIA) responded to growing concerns about the imbalance between supply and demand by further lowering its 2016 oil price forecast from US$40 per barrel (pb) to US$34. It’s since reversed this change based on a stronger outlook for global oil consumption. This should prove to be the low point for oil prices: The EIA expects them to head back up close to $51 pb in 2017.

This change brings the EIA into line with the Economist Intelligence Unit (EIU) and Oxford Economics, which both expect oil prices to be close to US$40 in 2016.

The EIU is the most optimistic about future prices: It predicts they’ll rebound to $56 in 2017. It believes consumption will exceed production for the first time since 2013. This forecast is completely at odds with the assessment of Oxford Economics, who expects a much steadier rise in oil prices to lie ahead.

 

Interested to see what Advito’s oil price assumption will be?  Stay tuned for the June update of our Industry Forecast.