RaboResearch - Economic Research

In oil, rebalancing is the key word

Economic Comment

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This study was written in collaboration with Richard Brakenhoff.

  • Rebalancing plays a prominent role in the World Energy Outlook of the International Energy Agency, both on the demand and supply side
  • In the oil sector, rebalancing concentrates on the supply side
  • IEA expects oil prices to remain low, though increase gradually towards 2020; but it cannot exclude a scenario of persistently low prices
  • We also expect a price increase by 2020 as a base case, but we expect the rebalancing to be less smooth

In its 10 November World Energy Outlook (WEO) the International Energy Agency (IEA) sketches a changing landscape. Important changes in the composition of demand are expected, with China rebalancing towards a less energy intensive economy and India stepping up its energy consumption on the back of economic and demographic dynamics. In the oil sector, our focus here, the rebalancing concentrates on the supply side. Following last year’s price shock (see Behind the curtains of the oil price plunge), the oil market is adjusting to the new reality.

In its main scenario, the New Policies Scenario, the IEA projects a smooth re-balancing on the oil market, with prices staying low but gradually increasing towards USD 80/bbl in 2020 and steadily increasing thereafter to USD 128/bbl in 2040. This represents a significant downward revision of the short term price forecasts compared to the previous WEO when oil was expected to reach USD 113/bbl in 2020. This revision is motivated by the fall in oil prices as of July 2014, caused by higher than expected supply (mainly USA), lower than expected demand growth (China) and the changing role of the OPEC following their decision not to cut down on production to support prices.

Nevertheless, the IEA highlights it cannot rule out a scenario of even lower prices, in which oil prices reach an equilibrium in the USD 50-60/bbl range until well into the 2020s before edging higher towards USD 85/bbl in 2040. An important characteristic of this Low Oil Price Scenario is that it assumes that oil prices remain low because of structural underlying changes in the way oil supply and demand reach an equilibrium, while the base case scenario assumes the price decrease was driven mainly by cyclical elements. Consequently, this adverse scenario assumes i) OPEC supply to be more readily available as political risks in some countries ebb and OPEC continues with its market share defending strategy and ii) non-OPEC (particularly US) supply to be more resilient at lower prices. It also considers lower economic growth in particularly emerging markets, though the impact on demand is marginal. The lower oil prices cause the oil and gas industry to limit investments, particularly in North and Latin America (oil sands, deepwater oil and gas).

Recent developments in the oil sector as well as the analysis of IEA are largely in line with our rebalancing expectations laid out half a year ago (see Behind the curtains of the oil price plunge). Namely, we notice a ‘pork cycle’ in the sector as highlighted by the >20% reduction in both actual investment as well as in future CAPEX expenditure, and the steep fall in the rig count in the US as a result of the fall in oil prices (figure 2). As expected, we also notice that there is some stickiness in the supply response of US tight oil due to factors such as hedging and debt service obligations, as well as unexpected efficiency gains from cutting down costs and focusing on the most productive parts of plays.

Figure 1: Sharp fall in oil prices…
Figure 1: Sharp fall in oil prices… Source: Macrobond
Figure 2: … hurts number of US rigs but not supply
Figure 2: … hurts number of US rigs but not supplySource: US Energy Information Administration, Baker Hughes

Consequently, we also remain bearish on the oil price development in the short term. For one, although there are signs of US supply growth petering out (figure 2), a fall still remains to be seen. Meanwhile, stocks have reportedly reached historic highs in for instance China and the US amid an expected pickup in supply from the Middle East due to the lifting of sanctions on Iran. Besides, a stronger USD due to an imminent rate hike in the US also likely supports lower prices. As there are still many uncertainties (e.g. geopolitics in the Middle East and other OPEC countries) as also supported by the IEA in its Low Oil Price Scenario, higher short term volatility of the kind seen this year (Brent oscillated between USD 40-70/ bbl figure 1) is likely to prevail.

Figure 3: Forecast oil prices
Figure 3: Forecast oil pricesSource: IEA, Rabobank

However, we expect the rebalancing to be less smooth than the IEA (figure 3). Namely, the impact of the sharply lower investments made by the global oil and gas industry will be visible in global oil production in a few years’ time and lead to shortages. Therefore, we expect the oil price to recover from USD 50-55/bbl in the 2015-2017 period to around USD 95/bbl in 2020. Also, as these shortages push supply towards cheaper but politically more volatile countries (e.g. Middle East), geopolitically driven supply disruptions could lead to sharp oil price upswings.

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