The oil crisis will be solved only by a pick-up in global oil demand, once lockdowns are lifted, the economy is restarted, and, hopefully, a vaccine is developed.
Brent and WTI futures price timeline
2020 is proving to be the most tumultuous year for the global oil industry since the first Gulf War. The evaporation of demand for goods and services in the wake of the coronavirus pandemic, in conjunction with the inability of OPEC+ to adjust oil production early on in the crisis, has resulted in record price volatility for the commodity that fuels the global economy.
April’s historic drop of West Texas Intermediate futures contracts to -$36 a barrel from a January high of $60/bbl represents a near $100 swing in just four months. Today, WTI is back up $33.50/bbl, a $70 dollar rebound in 30 days. To say that this roller-coaster was nerve-wrecking is an understatement.
The road ahead will be tough for oil. Demand destruction of 30-40% of the global pre-COVID oil supply, record inventory builds, and the steady rise of renewables are all significant obstacles to overcome. I predict that we will see a bleak recovery period for the next few months, but once a vaccine is developed and demand picks up – which it inevitably will – we can expect oil to rise back to between $40-50 dollars per barrel in 2021. There are early encouraging signs that demand is already edging up from its nadir in April.
But the bounce-back will not happen fast. According to Royal Dutch Shell we may have already hit peak oil demand, a stark contrast with opinions from the likes of the IEA and British Petroleum who just months ago contended that global oil demand would continue to grow year-on-year for at least another decade. But as they say making predictions is hard – especially about the future.
It is my analysis, however, that in the absence of a second wave of pandemic we will see nearly all pre-COVID demand return by the second half of 2021.
EIA
The oil market will likely recover in three phrases, beginning with the Second Quarter of 2020. According to IHS Markit, during the current “crash correction,” 13 to 15 million bpd of crude production will likely be removed from global supply as demand shows signs of revival. The “massive inventory overhang” should not show material declines until June or even early July. As we move into Q3 of 2020 through Q2 2021 the oil market’s trajectory will be rather unstable, as it will be heavily linked to the “shape” of the pandemic recovery – influenced by testing, tracking and, hopefully, vaccination. The virus’ effect on consumer behavior and economic activity, especially in the context of transnational travel and the tourism industry, will have the greatest impact on oil industry outlook.
According to the US Energy Information Administration (EIA), Brent crude oil prices will average $34/bbl in 2020, down from an average of $64/bbl in 2019. The administration expects prices will average $23/bbl during the second quarter of 2020 before increasing to $32/bbl during the second half of the year.
Unlike in the past, the underlying supply in the oil market is not the problem. It is the decreased demand and economic uncertainty that has spawned from coronavirus. As risk mitigation techniques continue to advance through the year, and as we hopefully develop pharmaceuticals to counteract the virus while we wait for a proper vaccine, we will see a rise in oil demand mirroring that of confidence in the economy.
Beginning in the second half of 2021 the demand should return to 95% of pre-COVID levels, barred a prolonged crisis in international air travel. Sidelined productive capacity is likely to go back online and increased demand erasing supply overhangs (provided a second wave of the pandemic will not emerge). The EIA forecasts that Brent prices will rise to an average of $48/bbl in 2021 as declining global oil inventories next year will put upward pressure on oil prices. This does not include future geopolitical flare-ups in the Middle East, such as the US-Iran tit-for-tat witnessed in January, which could also drive prices higher.
Furthermore, a medium-term market squeeze may occur if hobbled suppliers are not able to ramp-up production fast enough to meet a healthy bounce-back in demand. A supply-demand mismatch here could mean a spike in prices. According to Wood Mackenzie, US shale – perhaps the most flexible producer in the world – may see its supplies decline by 30-50% in just one year as investment downturn squeezes the life out of the sector. It is still unclear how quickly the American shale patch will recover from this devastating period, or what the sector will look like in 2021. The same can be said of the oil supermajors and global national oil companies, such as Saudi Aramco and Rosneft, as they chart their course in murky post-COVID waters.
With Assistance from David Pasmanik
