Oil Market Recovery Is Slowing; Should We Worry?
“After the March/April collapse in oil demand due to Covid-19, there was a rapid recovery. Now, economic activity measures are slowing, suggesting that the oil recovery may be moderating. An interesting analysis of the oil market shows a wide range of oil price forecasts that should be a warning for questioning strategies”
Last week, The Wall Street Journal carried an article titled, “Fuel Rebound Loses Steam, Setting New Risks to Economy.” Another article in that same edition carried the title “Factories Ramp Up, but Layoffs Raise Concern.” The two articles are related, especially if one views economic activity closely tied to manufacturing, which drives energy use. The writer of the fuel article was describing the trend of gasoline sales since their collapse in March and the sharp rebound when state economies began reopening in April, after being shut down to fight the spread of the coronavirus. The economic re-openings have been spotty, marked by the emergence of virus hotspots, often forcing local and state governments to stop further loosening of restrictions, and in some cases, renewing lockdowns.
Exhibit 6. Gasoline Demand Within 10% of Pre-Covid-19 SOURCE: EIA, PPHB
As Exhibit 6 shows, gasoline supplied dropped 48% during the second half of March, but then rebounded 46% the following month. While the gasoline supplied continued growing to satisfy increased driving, analysts are concerned demand growth has essentially flat-lined since early June. There was a jump in supply during the week of August 21, but some of that gain was erased the following week. Volatility notwithstanding, what is significant is that the last week of August was only 10% below the mid-March volumes of gasoline supplied, at the start of widespread state economies entering lockdown or semi-lockdown.
U.S. gasoline consumption is important for the global oil industry, and for the health of the recovery. We also need to be concerned about oil’s use worldwide. The Energy Information Administration (EIA) published a chart showing jet fuel consumption by commercial passenger jets in important countries and regions. The chart plots the seven-day moving average of the ratio of current jet fuel consumption versus 2019’s volume. U.S. consumption at mid-August was 42% of 2019’s use, up from a 20% low of late April. China, who experienced Covid-19 earlier and also began recovering sooner, saw its 20% low reached in late February and is now over 60%. In contrast to other countries and regions, China experienced a recovery bounce in early March, before then declining until early April. That recovery pattern was directly related to how China reopened its economy, which did experience some local retreats before resuming its opening.
Exhibit 7. How Air Transport Is Recovering SOURCE: EIA
To see where the world may be in its return to more normal economic activity, although we do not know what that means, we turn to Apple Mobility data. Unfortunately, China data was not available. We have selected a representative country in each region to see activity in relation to the virus. Not every country was impacted by the virus at the same time, which is evident in looking at the graph. And, some countries are experiencing a rebound in virus cases, suggesting that fighting a second wave may require resorting to the drastic lockdown strategies used earlier.
Exhibit 8. Global Recovery Shows Troubling Growth SOURCE: Apple Mobility, PPHB
What we see in the chart is how Germany and the U.S. seem to have tracked together when each country began reopening in mid-March. The tightness in reopening between the two countries seemed to end in mid-June when U.S. activity appeared to flatten, while Germany’s continued upward. Germany peaked in late July and then began declining, coming back into line with that of the U.S.
Looking at the other countries, it is interesting to see how Egypt’s recovery has steadily grown once it turned up in mid-May, but its activity has become more volatile since early July. On the other hand, India’s recovery has been steady since it bottomed in late-March, but the pace of the recovery has lagged that of other countries. This pattern is similar to the recovery experienced by South Africa. Both Brazil and Indonesia have experienced greater volatility as they recovered. We are not quite sure what to make of that greater volatility, but in general terms, the two countries are now showing a flattening in their activity. Overall, the picture of mobility data shows a noticeable flattening in activity globally, which is not a positive for a recovering oil market.
An interesting perspective on the oil market is contained in the KAPSARC Oil Market Outlook for 3Q2020, published in August. KAPSARC is the King Abdullah Petroleum Studies and Research Center in Saudi Arabia. Their forecast takes a much more nuanced approach by factoring in risk factors. As they assess everything, their oil price projections are based off of the oil futures curve. What they show, however, is confidence ranges around that curve in their oil prices projections. As shown in Exhibit 9, at 95% confidence capturing possible price projections, the May 2023 price range is between $17 and $150 a barrel. Given that wide of a range, we are inclined to throw up our hands and say: This doesn’t help.
Exhibit 9. How Oil Prices Might Unfold SOURCE: KAPSARC
However, as the confidence range narrows to 68% and then 50%, the projected price ranges narrow substantially, to $37 to $70 at the lowest. While we may feel more comfortable with projected prices closer to the futures curve, the 95% confidence range should force you to think about how those prices could occur. That is the value of this study. It should make people preparing long-term business strategies think about the risk of their projections being wildly wrong.
As one would expect, researchers at KAPSARC focus a lot on the global energy business and the economy of Saudi Arabia. In that regard, researchers have produced a white paper entitled “Cooperate or Compete? Insights from Simulating a Global Oil Market with No Residual Supplier.” This paper, which requires extensive study, attempts to assess what would happen to the oil market – supply, demand, prices, and investment – if OPEC, led by Saudi Arabia, abandons its long-term role as the market-balancing supplier. What would happen to the oil market, and Saudi Arabia’s economy and government finances, if we had a totally free market?
We have experienced free markets briefly in 1985-86, 2014-15, and 2020. This last period also had the impact of the Covid-19 virus impact on economic activity. Each of those periods was marked by sharp price moves and increased price volatility. We won’t dig into the study other than to provide the highlights the authors included. They offer some interesting perspectives on how the oil market might unfold, and what it means for Saudi Arabia’s, as well as OPEC’s, strategy going forward.
We investigate a transition to a competitive world oil market in which OPEC — led by Saudi Arabia — stops acting as the primary residual supplier within the world oil market starting in 2020. Our modeling results include the following highlights.
In 2020, as OPEC ramps up production, Brent prices fall US$11.5/b below the World Energy Outlook (WEO) stated policies scenario of the International Energy Agency (IEA 2019).
From 2020 to 2030, prices recover as a result of demand response combined with a need for sustained investment in new long-term conventional production.
Only when capital approved for new conventional projects matches historic highs (present value of about US$125 billion per year) do prices remain below the WEO stated policies scenario through 2030.
Crude prices recover faster and exhibit significantly higher variability when investment in shale oil production slows and output peaks at 12 million barrels per day (MMb/d) versus 16 MMb/d in 2025.
A decline in short-term tight oil projects limits its role in balancing the market as a source of marginal production, compared to new conventional projects with longer lead times.
Saudi Arabia benefits financially by continuing to act as the primary residual supplier only with strong cooperation from other producers in OPEC and the larger OPEC+ group.
We find the last highlight very interesting, especially in the context of the recent United Arab Emirates agreement with Israel. We note that Saudi Arabia has just opened its air space to Israeli planes for the first time ever. The geopolitics of the Middle East are rapidly changing after centuries of antagonism. We believe the rise of U.S. oil production due to the shale revolution contributed to this geopolitical shift. What other changes did the shale revolution drive, and how might they be impacted if U.S. shale oil production never returns to its prior levels, let alone its growth trajectory? You need to be thinking about this as you assess the long-term future for oil.