Opposing forces will affect oil market balance
Sluggish demand growth may be matched by an almost as equally anaemic lift in output
The oil market in 2020 will, in our view, be dominated by three key themes—the global economic slowdown, the ongoing drop in momentum in the US shale industry, and the sticky non-Opec production growth. These are opposing forces with material impact on the oil market balance for 2020.
Oil demand worries are not going away. The global economic slowdown combined with the US-China tariff war clearly hit oil demand growth. In light of this, we expect oil demand to grow by 0.8mn bl/d year-on-year in 2019, compared to 5-year average growth of 1.5mn bl/d year-on-year. The growth rate is almost halved, demonstrating the impact of the economic slowdown.
Our expectation is that the global economic slowdown will continue into 2020, with a global GDP estimate of 2.8pc for the year. As such, we anticipate that the weak macroeconomic sentiment will persist. However, due to the IMO 2020 bunker specification changes and global winter temperatures back at more normal levels, we forecast oil demand growth to improve slightly in 2020 to 1.1mn bl/d year-on-year. One reason for this is the simple, but powerful effect that vanilla year-on-year comparisons have on growth rate. From October 2018, global oil demand growth slowed down markedly, making it easier to grow year-on-year from a softer base going forward.
US shale oil, led by the Permian Basin, has been the key factor contributing to global oil production growth the past few years. Oil pipeline capacity out of the Permian to the US Gulf Coast is in the processing of being lifted by what will be more than 2mn bl/d in the second half of 2019. This unprecedented expansion of infrastructure is potentially laying the foundation for significant production growth.
The global economic slowdown will continue into 2020
However, despite the removal of this potential infrastructure bottleneck, drilling activity is slowing down in the US shale industry. Horizontal rig count is down 177 rigs, or 23pc, so far this year, while fracking crews are down 94, or 21pc, during the same period. This points to a continued slowdown in US shale, even while pipeline infrastructure is expanding on a massive scale.
So far, the effect of this reduction in activity has been masked by a drawdown in drilled uncompleted wells, or Ducs. Currently, roughly 15pc of all the completed shale oil wells are former Ducs. We expect the shale companies to run out of Duc inventory by the end of the first half of 2020. If activity doesn’t rebound in the same period, US shale production growth will slow down further in the second half of the year, regardless of the greater availability of evacuation infrastructure.
Despite US shale growth slowing down, we expect 2020 to be another year with—for Opec, at least, uncomfortably—high increases in non-Opec production. Norway will see strong growth from its new Johan Sverdrup giant field, Guyana will mark its debut as an oil producer, and Brazil’s pre-salt production will continue to expand in 2020.
We estimate non-Opec production growth of 1.9mn bl/d year-on-year for 2020, compared to our oil demand growth estimate of 1.1mn bl/d. As such, we expect 2020 to be the third consecutive year with a decline in the space in the market for Opec volumes.
However, life for a majority of Opec members is likely to be made relatively easier by Iran and Venezuela, which will both record another year of declining production unlinked with any mandated Opec production cuts. As a consequence, even though our ‘call-on-Opec’ estimate drops by 0.8mn bl/d year-on-year in 2020, we only need Opec to cut 0.2-0.3mn bl/d from the current production level in order to balance the oil market in 2020—which is manageable.
It is difficult to make a bullish argument about the 2020 oil market balance, but, given these three key themes, we believe concerns about next year’s oil market balance are overdone. Our 2020 Brent oil price estimate of $64/bl compares to the forward market at $59/bl.
We expect the shale companies to run out of Duc inventory by the end of the first half of 2020
Any significant downside oil price risk for 2020 is primarily associated with a potential return of Iranian production (c.1.7mn bl/d) to the market. We do not think it is likely that the US would lift sanctions on Iran, but, if that scenario played out, it could be rather unpleasant for oil prices.
We would not expect other Opec countries to cut back in order to give room for any Iranian production. In which case—if the Iranian barrels returned—the oil price would need to be significantly lower to rebalance the market, which we believe could send Brent down to the $40-45/bl range.
Upside oil price risk to our base case is linked to a rebound in the global economy—with a corresponding rebound in the energy-intensive manufacturing sector—which would do wonders for oil demand growth. In the event we see a rebound in the global economy, combined with continued capital discipline in the US shale sector, it could push Brent above the $70/bl mark in 2020.
Finally, we see a significant slowdown in non-Opec growth post 2020, due to a combination of low upstream project sanctioning activity in 2015-17, combined with a forward curve of WTI below free cash flow breakeven for the shale industry. The latter will make it difficult to change the shale industry’s modus operandi from capital discipline back to growth. As such, we are increasingly bullish about the oil market post-2020 from a supply perspective.