Economic doom and gloom remain the order of the day, so little wonder that hedge funds and other money managers spent the last week of September and the first part of October selling down their oil futures positions.
After a series of attacks on tankers in or near the Strait of Hormuz and in the Red Sea this year, vessel seizures, and then the major strike on the key Saudi oil facility of Abqaiq, it appears that nothing short of a conflict directly affecting at least one major Middle Eastern oil producer will drive up the price of oil.
OPEC production was down 1.6 million b/d in September from August, the lowest level since November 2003, but the price of Brent crude is back below $60/barrel.
The International Monetary Fund’s (IMF) October World Economic Outlook confirmed the uncertain outlook. The world economy is now forecast to grow at 3.0% in 2019, 0.3% lower than the IMF’s April projection. There are few signs that the economic situation has hit rock bottom and is entering a recovery phase. Further downgrades are still possible.
In particular, the Fund noted that manufacturing activity has weakened substantially to levels not seen since the financial crisis of 2008/09, although the service sector remains relatively resilient. The OECD’s Composite Leading Indicator continues to deteriorate, reaching 99.06 in August, notching up 20 continuous months of decline.
The Fund sees growth of 3.4% in 2020 and a slightly higher growth rate for 2021-24 but notes major downturns in many large developing market economies. It is their recovery in 2020 and beyond which underpins stronger growth and also stronger oil demand as growth in four key areas, representing half of global GDP – China, the euro area, Japan and the US – is expected to moderate.
As a result of the weakening economic outlook, the US Energy Information Administration has dropped its forecast for Brent by $5/bbl to $57/bbl in second-quarter 2020 as inventories rise in the first half of next year before the market tightens in the second half. Brent prices for second-half 2020 are forecast at $62/bbl. Again, this is a recovery-based scenario that does not entertain any further deterioration in the global economy.
While lower oil prices are weighing on US shale oil drillers, and hitting the oil services sector hard, such is the momentum behind US oil production that output will take time to slow. The EIA estimates US crude production will still increase by 0.9 million b/d next year to an annual average of 13.2 million b/d, building on the estimated 1.3 million b/d rise this year.
The International Energy Agency, in its latest oil report, sees total non-OPEC production growing by 2.2 million b/d next year, driven by the US, Brazil and Norway, but has crimped its demand forecast for 2020 again by 100,000 b/d to 1.2 million b/d, reflecting slower global GDP growth.
Adrenaline shot needed
To reverse this outlook, business confidence needs an adrenaline shot and quickly. The only likely source of such a tonic is the US-China trade talks, which according to US President Donald Trump are going well and could produce a deal on the first phase of the overall negotiations by the middle of next month in time for the Asia-Pacific Economic Cooperation meetings on November 16-17 in Chile.
The imposition of more tariffs has been avoided for now, but the Chinese description of the situation as ‘talking while fighting’ does not inspire confidence that a meaningful deal will be reached that results in a rapid reduction in trade tensions. 15 months on and it seems a long road back to what might be termed pre-trade war ‘normality’.
In the short-term, global oil inventories should continue to fall. Seasonal summer demand in the northern hemisphere has been relatively strong and the huge Saudi outage will dent oil in storage.
But it is a likely surplus in first-half 2020 that OPEC will have to address when it meets next in December. Further cuts to supply, underpinned by Saudi Arabia and non-OPEC member Russia, are likely to be needed to restore a semblance of market control by the producer group.
Saudi Aramco is still pursuing plans for the partial floatation of its giant state oil company Saudi Aramco. It will not want to curtail production in such circumstances, but a reassertion of OPEC’s market relevance may be the only way to boost confidence.
The gloom can lift but it will take a combination of factors to do so: real progress in the US-China trade talks and the lifting of some tariffs; an orderly Brexit, or at least some reduction in uncertainty; and further supply curtailments by the OPEC+ grouping.