What does a balanced oil market mean?
Supply and demand might come back into line this year, but without the kind of price
rises the industry hopes for
IF ONE bit of jargon captures the hopes of the oil industry right now, it's "rebalancing". The term has become ubiquitous and it means that the glut will have ended. Supply and demand will be in balance. Things can get back to normal.
Elsewhere in our July/August issue, we note the consensus: that the rebalancing is underway. The International Energy Agency (IEA) thinks so. It says faster-than-expected demand growth in the first half of the year and recent supply outages have combined to mean the market will be "balanced" in the second half. Stocks will fall in the third quarter. Demand, says the IEA, will rise by a robust 1.3m barrels a day this year and at the same pace in 2017.
This is bullish. If the glut caused the price collapse, ending it will lift the market. Even the sharp sell-off in oil markets in the first week of July, which sent Brent back beneath $50 a barrel, reinforces the logic. Weaker oil prices will lead to less production and more consumption. The cure for low prices is low prices. It's basic supply-demand logic.
But two factors mean no one in the industry should dust off the party bunting. The first is the fundamentals, which could yet unbalance things again. The second is the worsening macroeconomic backdrop. The market might reach an equilibrium - achieve balance - but with little bullish impact on prices.
The production losses have certainly been steep. The IEA reckons non-Opec supply in May was 1.3m b/d less than a year earlier. The US alone has shed 1m b/d since April 2015, says the Energy Information Administration (EIA).
Now the fears are greater –
reflected in everything from
the collapse of bond yields to
the strengthening of the dollar.
As an asset, oil is no longer a
beneficiary of this flight to safety
But at prices around $50/b, the worst is probably over. The US rig count has ticked up. Non-Opec supply is expected to rise by 200,000 b/d next year - a fraction of the growth seen before the crash, but still growth. Plainly, oil producers have adjusted. In the American oil patch, the most dynamic and price-reactive corner of the market, cost savings are still being found. Thanks to greater efficiency, investment bank Goldman Sachs expects the US to add 100,000 b/d to supply next year and another 0.8m b/d in the two years after.
"Companies also appear to be sanctioning projects again after an 18-month hiatus," the bank said in a recent note. On cue, Chevron and its partners announced plans to spend $37bn on the Tengiz project in Kazakhstan, eventually adding 260,000 b/d to output. Meanwhile, despite the violence in Nigeria's delta region - which sharply cut supply - persistent chaos in Libya's oil sector, and a political crisis in Venezuela, Opec's output in June hit another high of 32.8m b/d, according to a Reuters survey.
Some of the extra oil came from a recovery in Nigerian production. That might not last. But the outages that struck global supply in the second quarter look likelier to ease than worsen. Fire-struck Canadian output is regaining ground, northern Iraqi oil is flowing through Kurdistan again, peace talks in Colombia could end disruption to its pipelines. Even in Libya, some signs of cooperation in the oil sector bring hope for a swift rise in exports.
More supply would put the rebalancing onus on demand. But that's worrying. Some analysts now believe China's strategic petroleum reserve will be full in August and, combined with less oil thirst from its teapot refiners, the country's imports will drop. Data from the US are troubling. The market has been agog at the surge in US gasoline demand this year. But, as Bloomberg analyst Julian Lee points out, it may have been a chimera. The EIA's monthly figures - more accurate than those it updates weekly - show overall American oil demand fell by a huge 350,000 b/d between March and April. Gasoline demand also dropped. At a stroke, the EIA's revisions flattened a bullish force.
The macroeconomic backdrop is downright ugly. Forecasters were already lowering global GDP growth outlooks before the UK's Brexit vote. Now the fears are greater - reflected in everything from the collapse of bond yields to the strengthening of the dollar. As an asset, oil is no longer a beneficiary of this flight to safety, but a casualty. And while a recession in the UK won't much trouble oil-demand forecasts, wider EU economic weakness will.
After analysing the yield curve in American bonds, meanwhile, Deutsche Bank now says there is a 60% chance of recession in the US in the next year. Whether it was a symptom of malaise or is now the trigger for a global weakening, Brexit poses threats. The macroeconomic models used by the IEA to forecast demand will be crunching new global numbers - the agency's July outlook might not be as bullish as the June one.
Despite all this, most of the industry assumes the market's "rebalancing" will bring oil-price inflation. But what if $50 is now par? In real terms, that's roughly crude's average price since the early 1970s - the market, in other words, may just be bending to the economic law of the reversion to mean.
The fundamentals will rule in the end, as they always have. But look at the long-term price graph, and the bonanza years are the exception not the rule. A few years ago, while oil was comfortably trading above $100/b, Petroleum Economist sat down in Dubai for a long and generous lunch with a key Saudi policymaker. What he said then seemed radical. The kingdom could deal with cheap oil as it had in the past, he insisted, and $50/b would be just fine. His words no longer seem so shocking.