Now that OPEC has left its production quota unchanged, the world will continue to see a glut in supplies, right?
Some analysts aren’t so sure. Sanford C. Bernstein predicts that by the end of the year global demand will outstrip supply by an estimated 1.5 million barrels per day.
That flies in the face of a lot of separate estimates. The IEA says that oil supplies are still in excess of what the world is consuming, by some 2 million barrels per day. Even with flat supplies coming from US shale, drillers are still pumping way more oil than the world is consuming. That leaves Bernstein as an outlier when it comes to guessing which way oil markets are heading.
But there is reason to believe that Bernstein is not off the mark. While market analysts are right to closely watch the trajectory of US production levels as well as what OPEC is up to, a lot less attention is being paid to the demand side of the equation. Part of OPEC’s strategy, we must remember, is to ensure the world stays hooked on oil for the long haul. The cartel’s strategy of keeping prices low dovetails with that – low prices reduce the urgency to transition away from crude oil.
And their strategy is bearing fruit – demand is growing quickly. The IEA said in its May report that “global demand growth gained momentum in recent months.” That is certainly true in the US, where motorists are hitting the roads at levels not seen since before the financial crisis. Seduced by lower prices, gasoline consumption is at its highest level since 2007, after years of stagnation. Low gas prices are also giving a boost to SUV sales as drivers cast off their energy efficient ways at the first sign of weak prices.
That suggests that OPEC’s strategy is working.
Of course, if demand does continue to rise, that will put an end to the low prices that spurned the rise in demand to begin with. Oil prices will rise in response to higher demand and the cut back in US shale production, and OPEC will have balanced the market back in its favor, having seized market share.
If Bernstein is right, however, and demand exceeds supplies, then oil prices will have to rise quite a bit. Already crude oil inventories have posted several consecutive weeks of drawdowns, an indication that the glut is no longer building, but rather is already in the process of abating.
There are several possibilities that would completely upend this scenario, however. The first is that demand slows as prices rise and there is a market equilibrium found, with prices leveling off in the $70 to $80 range.
But there is another possibility that Bernstein may be overlooking: the potential wave of new production coming online in the months ahead. Iran is on the verge of rejoining the international community, opening the flood gates to 400,000 barrels per day in the near-term. That number could double or triple within a year.
Iraq is projected to lift oil exports by 100,000 barrels per day in June, and that number could continue to rise.
Yet one more OPEC nation could also boost production. Libya, suffering under years of war, could potentially add another half million barrels of oil per day to global supplies, perhaps as early as July when oil export terminals are put back into service. Taken together, these OPEC members could add multiple millions of barrels per day. And that would come on top of very high levels of production as OPEC is already exceeding its stated quota.
In other words, the Bernstein report is correct to note that demand is rising in response to lower prices. But it is far from clear if consumption levels will more than exceed the glut in supplies. A lot will depend on the rate of demand growth, as well as the magnitude of a supply cut from US shale.
By Nick Cunningham of Oilprice.com