Lockdowns, Fear, Life And Work Changes Hitting Oil Demand
“The Covid-19 outbreaks will cause the oil demand recovery to slow. Forecasters offer views of the future.”
If you haven’t been living under a rock, you know that Western Europe and North America are experiencing another wave of Covid-19 infections. The sharp increase in cases, hospitalizations and deaths has forced political leaders to reinstitute more restrictive measures to curb economic activity and social mobility, translating into reduced oil demand. The extent and duration of the current Covid-19 outbreak is unknown, but the popular perception is that we are headed for “dark winter months.” That view is despite the good news of the announcement of the successful development of a vaccine by drug company Pfizer, with plans to begin delivering doses to Americans within the next few weeks.
The fear of further setbacks to the global economic recovery translates into expectations for lower mobility and industrial oil demand. Virtually every oil forecaster is revising lower their demand projections for the balance of 2020. OPEC cut its 2020 demand forecast by 300,000 barrels per day (b/d), implying an overall demand drop this year of 9.8 million barrels per day (mmbbls/day), a 10% decline from 2019. The International Energy Agency (IEA) expects this year’s oil demand to fall by 8.8 mmbbls/d. That estimate reflects a 400,000 b/d increase from its forecast last month, but the overall demand decline is still a record. Neither revision is surprising given the virus news and reduced pace of economic recovery.
For the oil industry, the bigger question is what 2021’s demand will look like, especially given the Pfizer vaccine, and reports that Russia and China are deploying vaccines. The uncertainty about the timing and efficacy of the vaccines means projecting 2021’s economic activity and its resulting oil demand remains a guessing game. OPEC’s economic forecast for 2021 was lowered recently from a 4.5% increase to a 4.4% gain. A 0.1% cut in the growth rate doesn’t seem like much, but it will likely impact those sectors most energy intensive. If the vaccine is rolled out rapidly and Covid-19 infection rates drop sharply, economic activity will ramp up quickly, given the pent-up energy among societies and growing confidence of a return to a more normal lifestyle and working environment. What are the odds of this happening? More importantly, what is the likely timing? The IEA doesn’t expect the vaccine deployment to have much impact on improving economic activity during the first half of 2021, therefore, they are sanguine about the outlook for oil demand. Most other forecasters expect improvement in 2021, but not until the second half of the year and leading into a much improved 2022 demand.
For the IEA, the issue about oil prices is twofold. First, the cuts in activity and demand have been centered primarily in the developed economies (OECD countries), while developing economies such as China and India are experiencing faster rebounds. But the second consideration is the inability of OPEC and its fellow exporters (primarily Russia) to curb global oil output. Therefore, the IEA sees oil inventories not improving materially through the first quarter of 2021. If OPEC+ elects at their upcoming early December meeting to hold to their production cuts, global demand growth next spring will help begin to shrink the inventory overhang, providing room for oil prices to improve. Again, all of these forecasts are tenuous and subject to many considerations, any one of which can derail or accelerate the pace of recovery for the oil market.
This leads us to the bigger question of oil prices. Friday afternoon, oil trading closed at a little over $40 a barrel. Since June, oil has traded within a range of $36 to $43 a barrel. Relative to where oil prices have been over the past few years, this trading range is somewhat narrow, especially when one considers how economic activity and the virus have oscillated between optimism and pessimism. With oil prices around $40 a barrel, the drilling rig count continues to improve, as has the fracking crew count. These are signs that producers feel comfortable they can make money with oil in this price range, which says something about how they have reduced their cost structure, or that they are optimistic the recovery will gain speed, lifting oil prices higher as production declines in response to the spring oil-price implosion and resulting collapse in demand and capital spending. Which answer remains unknown.
Exhibit 3. Oil Prices Are 20% Below L-T Average SOURCE: EIA, BEA, PPHB
To put the oil price issue into context, we have updated our chart of real oil prices since 1947. It shows that the average real oil price over this period was $48.87. The average nominal price was $25.66.
Certainly, average prices are influenced by the extended periods of very low and very high prices. If we calculate the average prices for 1973-2020, the real oil price averaged $60.91 per barrel, while the nominal price averaged $38.03. We have shown the average real and nominal oil prices for various periods of history, with a brief description of market conditions, demonstrating how different various historical periods have been.
Exhibit 4. How Crude Oil Market Conditions Changed SOURCE: EIA, BEA, PPHB
The question remains about how long we will be living with oil prices at current levels. With oilfield activity increasing with oil prices around $40, producers are comfortable, although they certainly would like higher prices. We doubt the current low oil price environment will last for as long as it did after the mid-1980s oil price crash – 17 years. With the industry’s continued struggle with over-leveraged balance sheets, at the same time government policies are working diligently to reduce global fossil fuel demand, there remain many imponderables about the future we can only speculate on. We harken back to the “lower for longer” mantra of BP plc’s CEO Robert Dudley introduced in early 2015, as he described the mentality of his management team in their planning for the future. We recommend keeping that mantra at the forefront of your thinking about the future for the oil industry. We will enjoy higher prices, but can’t plan on them.