Edison published its latest oil and gas macro outlook on 27 January 2016. Below are highlights of the short term thoughts.
Market thesis: Oversupply to remain in the short term
The oil markets have been in turmoil now for 16 months, with recent trading at its most tumultuous in years as crude prices have plummeted to levels not seen since mid-2004. A Saudi-led OPEC market-share protectionist policy has driven a marked increase in inventories over 2015, with lifting of Iranian sanctions and potentially slowing Chinese demand set to extend the supply overhang.
The US Energy Information Administration (EIA) in its recent Short-Term Energy Outlook (STEO) forecasts that, having run at an average of 1.9mmb/d during 2015, this inventory build is likely to continue with an additional 0.7mmb/d supply overhang in 2016. Based on this analysis we are not likely to see a reversal of this trend for at least another 12 months, with stock reduction only envisaged from mid-2017 onwards.
This is despite non-OPEC countries reigning in investment that the EIA expects to result in a marked decrease in non-OPEC production in 2016 (c 0.6mmb/d) and relatively flat global demand growth of c 1.4mmb/d.
The reason for a growing inventory overhang, and depressed prices, is of course due to continued production from OPEC. Including non-crude liquids, this grew 0.9mmb/d in 2015 to 38.3mmb/d, with the EIA forecasting an increase of 0.9mmb/d in 2016 and 0.9mmb/d in 2017.
Libya and Iran form the majority of this potential additional supply. The EIA is estimating that with recent international sanctions being lifted on Iran, this could immediately add a further 0.7mmb/d onto the global market. We caveat this, however, given some reports that some of this capacity could already be being exported through neighbouring countries, while there are conflicting reports of the capacity and time that it will take Iran to increase production after years of sanctions.
2016/17 outlook: Going with consensus
The short-term oversupply outlook is clearly going to continue to add downside pressure to oil prices over 2016 and 2017. While we recognise that there are sensitivities to the views presented here (predominantly using EIA data), we do not claim to have more insight than the global agencies and hence for prudence we propose to align our near-term (2016/17) forecasts with those of the agencies. The EIA published its Short-Term Energy Outlook on 12 January 2016 and hence we use these data for our current assumptions. These forecasts for Brent and WTI are shown below.
As a sense-check to EIA forecasts, we have also considered the consensus numbers from research published on Bloomberg. Based on forecasts updated since end 2015 (to take into consideration recent market turbulence), we see that EIA forecasts are broadly aligned with Bloomberg consensus.
Sensitivities: ‘Lower for longer’ or a ‘structural bounce’
We have aligned our assumptions with EIA forecasts as the complexity and current volatility of the oil markets does not support independent analysis. However, we recognise there are compelling reasons for both bulls and bears to argue for different assumptions.
‘Lower for longer’: Some analysts (including Goldman Sachs, Morgan Stanley and RBS) called a $20/bbl bottom in December 2015 after a recent OPEC meeting did not agree any production cuts. This is based on break-even cash costs for highly levered US shale producers before production has to be shut-in. We would not fully support this view with many high-cost producers in the US likely to have higher break-even prices than this, although the sentiment has logic. The US service industry in particular has been very responsive, driving down costs to keep many marginal fields still economic at lower oil prices.
As well as exacerbating the supply glut and keeping prices depressed, the service cost deflation that we have seen during 2015 and into 2016 both provides a window of opportunity for oil companies looking to improve project economics and could potentially have a long-lasting impact on the global supply cost curve. We consider the impact of this on long-term oil prices later in this report.
Finally, it is worth noting that Standard Chartered has even pushed short-term oil price forecasts to as low as $10/bbl, although it states that this is based on financial flows caused by fluctuations in other asset prices rather than oil market fundamentals.
Structural bounce: On the flip side of the above argument, many believe that geopolitical forces simply cannot support sustained low prices. Many OPEC and MENA oil-producing countries require substantially higher oil prices to balance national budgets (Exhibit 8 shows this analysis, albeit with data from March 2015 and will not consider the global cost deflation seen during 2015). We could therefore expect there to either be structural cooperation to combat low prices across the wider market (OPEC and non-OPEC) or risk increased political instability.
OPEC may also be changing its stance with reports that even this week it has made an appeal to non-OPEC nations (primarily Russia) to work together on supply cuts that would boost prices. However, whether such a wider collaboration agreement is possible is still questionable with many countries both within OPEC and outside probably not in a position to sustain the impact of production cuts on a long-term basis.