Why the oil market imbalance will last for half of 2015

The price of crude oil has dropped dramatically from its above $100/b highs to sub-$50/b levels, with a near term projection to the $40/b support level – all within a year. The root cause of the rout has been a surge in non-OPEC supply to its highest level ever and a contraction in demand growth to five-year lows.

While the bottom is expected to be hit by 2H 2015, it is expedient to examine the underlying factors that could influence the market imbalance and prolong the journey to the bottom.

On the demand side, although demand growth is expected to gain momentum in 2015, the acceleration is expected to be more modest than previously foreseen. According to the Oil Market Report published by International Energy Agency (IEA), “the outlook for global oil demand growth for 2015 has been cut by 230 kb/d to 0.9 mb/d on lower expectations for the FSU and other oil-exporting countries.”

According to the report, this is as a result of “a strong dollar and the lifting of subsidies [limiting] supportive price effects on demand, which is now seen reaching 93.3 mb/d in 2015, from 92.4 mb/d in 2014.”

A strong dollar impacts commodities priced in dollar by making them more expensive for buyers using other currencies.

On the supply side, oil production is expected to slow down for non-OPEC producers to 1.3 mb/d in 2015, after the surge in US light tight oil supply pushed non-OPEC production to record growth of 2 mb/d in 2014.

However, there would still be significant growth in supply for the first half of the year. The IEA report forecast that global oil inventories would notionally build by close to 300 mb in 1H15 in the absence of disruptions, shut-ins or cut in OPEC production.

According to the report, “if half of this took place in the OECD, stocks there would approach 2,900 mb and possibly bump against storage capacity limits.”

The supply and demand interplay shows a lag in market response to declining prices –which has prolonged the decline. Oil prices have been falling over the last six months and it is estimated the imbalance in the market would remain for another four to six months.

According to US Energy Information Administration’s Short-Term Energy Outlook,  “global oil inventories are expected to continue to grow by 0.9 million bbl/d during the first half of 2015, but to taper off by the end of the year as non-OPEC supply growth, particularly from the United States, weakens because of lower oil prices.”

Between then and now, the primary factor prolonging US supply growth, despite the low economical price level, is the oil producers’ access to financing.

“So long is the lead of oil projects that price swings can take time to work their way through to supply. Projects that have already been funded will for the most part go on”, say the IEA report.

It explains further, “when it comes to supply, lower oil prices are already slashing producers’ spending, but this is more likely to affect medium- and long-term output than short-term supplies. Non-OPEC supply growth for 2015 will not come close to its 2014 record, but prices have little to do with it – as things stand now.”

As producers continue to produce till funding dries up, global oil inventories will continue to build in 2015, keeping downward pressure on oil prices.

The US EIA forecasts that Brent crude oil price will average $58/bbl in 2015. Also, based on current market balances, EIA expects downward price pressures to be concentrated in the first half of 2015 when global inventory builds are expected to be particularly strong. It is expected that Brent crude oil price will increase through the remainder of the year to average $67/bbl during the fourth quarter in 2015 as the adjustments occur through the year.

An offshoot of sustained pressures on oil price is unplanned production cuts as a result of unrest.

As the US EIA points out, several OPEC and non-OPEC oil producers rely heavily on oil revenues to finance their fiscal budgets. Some producers have adjusted their upcoming budgets to reflect the crude oil price decline. If crude oil prices continue to fall or are sustained at a lower level, then oil-dependent producers will have to make tough policy decisions. These decisions could potentially lead to austerity programs and fuel subsidy cuts that could spark social unrest, leaving some countries vulnerable to supply disruptions if protesters target oil infrastructure. Potential new supply disruptions are a real possibility in a lower-than-expected price climate and present a major uncertainty in the world oil supply forecast.

This brings in a considerable measure of uncertainty into any forecast for 2015.

Yinka Abraham