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Oil-market forecasting: A thankless task

Supply and demand are behaving in ways the IEA did not previously expect

If only Benjamin Franklin had lived to see today’s oil market. Nothing is certain in life but death and taxes, the great man said. These days, he might have included revisions to oil-demand and supply forecasts.

In 2010, the International Energy Agency (IEA) warned consumers that “the age of cheap oil is over”, saying "a veil of uncertainty" was hanging over global energy security because of rampant oil demand and flagging production.

In its latest Medium Term Oil Market Report (MTOMR), which offers up the agency’s thoughts about supply and demand from now to 2021, the message is the opposite: brace yourselves for a lengthy period of low prices. Future supply constraints? Not so much.

Don’t blame the IEA for getting it wrong before. It wasn’t alone and, to give the agency its due, it remains the best source of data in a market that is still too opaque and too reactive to short-term price movements. Picking out trends isn’t easy.

If supplies are no longer threatened by peak oil, meanwhile, that doesn’t mean everything is rosy in the industry. Capital spending across the sector plummeted last year by almost a quarter and will drop again by 17% in 2016, says the IEA. Energy consultancy Wood Mackenzie reckons $380bn worth of upstream investment is being chopped from budgets. Yet the IEA believes it will take at least a year for commercial crude stocks to draw down enough to coax oil prices much higher.

A new outlook

Demand – by far the hardest side of the market’s equation to calculate – is where the agency’s record is shakiest. The IEA thinks consumption, which last year stood at 94.4m barrels a day, will reach 100.5m b/d in 2020 – a whopping 1.3m b/d higher than it forecast in last year’s report. The new number is based on revisions to earlier demand estimates. The 2015 MTOMR underestimated European consumption for that year by 300,000 b/d; and Chinese by 0.6m b/d.

More oil needed

The persistence of oil’s slump is behind the new outlook too. “Lower-than-expected oil prices during 2016-18 support marginally higher demand estimates,” its new report says.

While “more rapid economic growth” will eventually lift demand, “relentless stock-building” has also demolished the IEA’s earlier forecasts for prices. They didn’t start rising in 2015, as the agency earlier expected, and now won’t until 2017.

The latest MTOMR paints a mixed picture across the board. Global oil demand last year rose by 1.4m b/d, the IEA believes. But this won’t be repeated. In 2016, the agency thinks consumption will grow by a still-healthy 1.2m b/d, but pulses won’t be racing again thereafter.

“Any expectations that the most recent fall in oil prices to $30 a barrel will provide further stimulus to oil demand in the early years of our forecast and send annual rates of growth above 1.2m b/d are likely to be dashed,” the IEA says. The extra 7.2m b/d of oil the world will need by 2021 (compared with last year) will still only yield annual growth of 1.2%, or half a percentage point below its average between 2009-15.

Asia will account for 5.3m b/d of that increment. But that masks another significant trend in China, the engine of oil-demand growth over the past decade, where the pace of annual increases is slowing. In 2009-15, oil demand rose by about 5%. From now until 2021, it will do so by just 3.4%. Still, that’s 2.5m b/d more oil that China will need, says the IEA.

Supply growth

Slowing too, though, is global oil-supply growth. It grew by 2.4m b/d in 2014 and 2.6m b/d in 2015. Between 2009 and 2015, the world added 11m b/d of capacity. Between now and 2021 supply will increase by just 4.1m b/d. That includes Iran, which the IEA expects to be Opec’s biggest source of growth – but adding just 340,000 b/d by 2021, or less than half the volume Iran says it will bring on stream.

The risks to this supply outlook are plain too. The biggest comes from US tight oil supply, which despite ending 2015 with its first year-on-year decline in five years, will “rise again”, says the IEA.

Tight oil output will fall by 0.6m b/d this year; and by a further 200,000 b/d in 2017. But with gradual updraft in prices will come a recovery: growth of 280,000 b/d in 2018 and then, by 2021, year-on-year growth of 0.55m b/d. It will leave US tight oil output at around 5m b/d, compared with an average of 4.3m b/d last year. “Anybody who believes that we have seen the last of rising LTO production in the US should think again,” says the agency.

Indeed, across the US, improvements in operational efficiencies and cost cutting will insulate the sector. By 2021 total US liquids production will be about 14.2m b/d, or around 1.3m b/d higher than in 2015.

By contrast, Russia and Saudi Arabia, the US’ nearest producer rivals, will reach nothing like that level of output. Russian production will fall by 275,000 b/d to 10.8m b/d in 2021, the IEA thinks, as capex constraints, sanctions and fiscal pressures take their toll.

Like most of Opec, Saudi production capacity (about 2m b/d of which it presently does not use) won’t rise much in the IEA’s forecast period: by just 70,000 b/d between 2015 and 2021.

The rest of the group – wilting under export revenues that will hit just $320bn this year compared with $0.5 trillion last year and $1.2 trillion in 2012 – won’t muster much of an increase either, the IEA believes. Total group production capacity will grow from 35.64m b/d last year to just 36.44m b/d in 2021. That’s 0.8m b/d of extra Opec oil (capacity), but in the same period the IEA expects the call on the group’s crude to rise by 4.7m b/d, to 34.8m b/d. According to those forecasts, Opec’s effective spare capacity would fall to just 1.64m b/d – the kind of number that spikes prices.

Some of the group’s producers will lose capacity – Algeria’s will fall by 170,000 b/d, for example, leaving its output under 1m b/d in 2021, says the IEA. The main exceptions will be Iran, Iraq, the UAE and Libya.  

But here too the IEA is hostage to events beyond its control. Iran’s government, for example, will be deeply disappointed if capacity rises only to 3.94m b/d by 2021 – or about 1m b/d beneath its 5m b/d target for 2020. The IEA expects 270,000 b/d more oil from Iraq in the next five years – but Baghdad still has much bigger plans, and has repeatedly defied the doubters.

As for Libya, the IEA expects production to rise over the next five years by 190,000 b/d. But this seems arbitrary. Either Libya’s chaos will end and production will rise much more steeply towards its pre-2011 capacity of 1.6m b/d. Or the political dysfunction will persist, making it difficult to see the source of any new output growth. The wildcard is Libya’s southwestern fields, Sharara and El Feel, which may return to production in spite of the chaos. But these would add about 300,000 b/d.

Those plausible discrepancies all point to the deeper problem for the IEA. It is charged with making forecasts during a period of deep uncertainty for the market. It’s an unprecedented era, and it has made fools of many other forecasters too. As the agency writes, “we are living in perhaps the first truly free oil market we have seen” – and the implications are still not understood.

“In today’s oil world, anybody who can produce oil sells as much as possible for whatever price can be achieved,” the IEA says. “Just a few years ago such a free-for-all would have been unimaginable but today it is the reality and we must get used to it.”

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