Two Factors That Point To A Bearish 2020 For Oil

OPEC and allies had little choice but to roll over their production cuts into the first quarter of 2020 amid higher-than-average global inventories, continued uncertainties over the global economy and oil demand growth, and rising rival oil supply, mostly from U.S. shale.

The cartel and its non-OPEC partners led by Russia aim to bring the market back to balance and prop up oil prices, or at least put a floor under current prices.

While the OPEC+ alliance can and does calibrate its own production, it is not in control of the current key drivers of the oil market - demand growth and rival oil supply.

And the current outlook for those two variables point to an ugly oil market in 2020, oil and gas analyst Gaurav Sharma writes for Forbes.

Despite rising tension in the Middle East with the U.S.-Iran standoff, despite U.S. sanctions choking off oil supply from Iran and Venezuela, and despite a fragile security situation in Libya, OPEC’s extended cuts failed to excite the market.

That’s because supply from outside the OPEC+ group, especially from U.S. shale, continues to grow, inadvertently supported by the restricted supply from OPEC+. But more importantly, because market participants are currently more concerned about the state of the global economy—particularly in a still unresolved U.S.-China trade dispute—and its impact on global oil demand growth, than the likelihood of a major supply outage.

Major organizations have downgraded oil demand growth forecasts to reflect uncertainties about the global economy and the U.S.-China trade war. In its June Short-Term Energy Outlook (STEO), the EIA cuts its oil demand growth forecast by 200,000 bpd to 1.2 million bpd for 2019.

The International Energy Agency (IEA) also cut in June its demand growth outlook, to 1.2 million bpd this year.

World trade growth is now at its slowest pace since the financial crisis ten years ago, the IEA said, citing data from the Netherlands Bureau of Economic Policy Analysis and various purchasing managers’ indices. The consequences for oil demand have already become apparent, with growth in Q1 this year at just 300,000 bpd versus a very strong Q1 2018, the lowest for any quarter since the fourth quarter of 2011.

“A clear message from our first look at 2020 is that there is plenty of non-OPEC supply growth available to meet any likely level of demand, assuming no major geopolitical shock, and the OPEC countries are sitting on 3.2 mb/d of spare capacity,” the IEA said last month, suggesting that the market will be well-supplied, which means that there could still be an inventory overhang next year.  

OPEC’s latest forecasts see oil demand growth at just 1.14 million bpd this year, down by 70,000 bpd from the previous estimate. While demand is expected to seasonally improve in the second half of this year, OPEC expects the H1 slowdown in the global economy to be “further challenged” through the rest of the year.

In view of the gloomy demand outlooks, no one was really surprised (or impressed too much) with OPEC and allies extending the cuts into 2020.

The market reacted in the worst way to an OPEC meeting since the end of 2014, with prices plunging more than 4 percent.

“This does suggest that participants are more concerned about why OPEC needs to prolong cuts into 2020- weaker than expected demand growth, along with robust non-OPEC supply,” said Warren Patterson, Head of Commodities Strategy at ING.

The OPEC+ group is “drawing a line in the sand for $50 oil so they can stabilize oil prices until demand picks up,” Marc Bruner, chief executive at natural-resource firm Fortem Resources, told MarketWatch two weeks ago week.

Demand could pick up if the United States and China resolve their trade dispute, according to oil market expert Amrita Sen, who says oil prices could “easily be $75 if not slightly higher” in case of a trade deal.

Currently, a trade deal is nowhere in sight, but the two biggest economies in the world have at least decided to resume trade talks.

“President Trump wants to be re-elected and will therefore be prepared to sign a trade deal, probably in 4Q, that doesn’t necessarily meet all of his initial demands,” says Mark Cliffe, Chief Economist and Head of Global Research of the ING Group.

“We assume Trump will want the optimal conditions of rising equity markets and decent economic activity going into the campaign proper, and a trade deal together with lower interest rates can deliver that,” according to Cliffe.

In case of a trade deal, economies and market sentiment could rebound and support oil prices with brighter outlooks on global oil demand growth.