Economic Commentary
Will The Recovery In Oil Prices Continue?
Oil prices have enjoyed a recovery in recent weeks. They rose from USD28 per barrel (/b) in mid-January to around USD40/b now. While a potential production freeze by some oil producers might have contributed to the recovery, there are also signs that the market is rebalancing. Demand growth is proving resilient and high-cost US producers are cutting their output. We expect the rebalancing to continue and forecast oil prices to recover further, averaging USD41 in 2016, USD51 in 2017 and USD56 in 2018.
Brent crude oil price (USD/b)
Sources:Bloomberg and QNB Economics forecasts
According to estimates from the International Energy Agency (IEA), oil markets were over-supplied by around 1.8m barrels per day (b/d) in 2015. Four questions are likely to determine how this excess supply will be cleared and therefore shape oil markets in the short term. First, will the strong demand growth (which reached 1.8m b/d in 2015—a five-year high) persist? Second, how will the high-cost US shale producers respond to low prices, which are making some of their projects unviable? Third, what production will Iran add after the lifting of sanctions? Fourth, how will the rest of OPEC respond to low prices?We look at how the answers to these questions are likely to evolve in 2016-17.
Oil demand and supply changes (m b/d, annual average)
Sources:QNB Economics forecasts
In 2016, we expect excess supply to fall to 1.2m b/d from 1.8m b/d in 2015. Part of this contraction will be due to higher demand, which we expect to grow by 1.2m b/d. Emerging markets are likely to remain the main source of demand growth, given the booming consumer sector, especially in China and the rest of emerging Asia.On the supply side, we expect production cuts in the US. Indeed, production data show that US oil output has been in decline since April 2015. Offsetting this, we forecast additional production from Iran after the lifting of sanction. Iran has already added 370k b/d since January, according to preliminary data from the IEA. Finally, we expect that the rest of OPEC to increase supply relative to last year as crude production is maintained at current high levels. The overall reduction in excess supply should result in oil prices averaging USD41/b in 2016.
In 2017, excess supply should fall further to 0.4m b/d as the market continues rebalancing. Demand growth is expected to continue at 1.2m b/d. On the supply-side, additional production from OPEC, especially Iran and Iraq, is expected to be partially offset by lower US production. The continued rebalancing should push prices to an average of USD51/b.
In the medium term, oil prices should be determined by the cost of the marginal producer, in this case US shale companies. Oil analysts currently estimate this cost to be USD60/b. We therefore expect a gradual convergence of oil prices to this level, leading to an average oil price of USD56/b in 2018.
To conclude, oil markets are not different from other markets. When over-supplied, they have a tendency to self-adjust through higher demand and lower supply. This adjustment is currently underway, as recent data confirm. In the medium term, the price is determined by the costs of US shale companies. If prices rise above shale companies’ cost, they can quickly respond by increasing their production, driving prices down again. This means that oil prices of USD100/b may well be a thing of the past, but a price of USD60/b is probably within range in the medium term.