Commentary: Oil set for a long and rocky road to recovery
Current price stability is partly an anticipation of strengthened demand over the rest of 2020 and the OPEC plus stepping up cooperation, says Boston Consulting Group’s Dave Sivaprasad.
SINGAPORE: The oil and gas sector remains beset by extremely challenging market conditions.
Demand has been driven down by social distancing measures and economic shutdowns, which have driven the global economy into deep recession.
The latest International Monetary Fund (IMF) estimate is -4.9 per cent growth this year. It is also estimated that 90 per cent of countries will experience economic contractions in 2020.
Global demand for oil is now expected to be 8 million barrels a day (mbd) or more below the 2019 levels - nearly triple the drop from the worst of the global financial crisis of 2007 to 2009.
Oversupply issues cast a persistent shadow, with storage levels high and OPEC plus - a group of 23 countries including the 13 OPEC members - being forced to slash record levels of production in the face of the demand contraction.
The supply and demand pressures highlighted above could deepen if we were to see waves of COVID-19 cases, triggering further mobility and economic restrictions in major markets.
Despite the challenges, oil market volatility witnessed in the early days of COVID-19, when prices fell to below US$0, has largely evaporated. Brent oil prices have remained steady at around US$40 to US$45/barrel (bbl).
OPEC PLUS WILL DICTATE MARKET TRAJECTORY
This price stability is partly an anticipation of strengthened demand over the rest of 2020. But it is also due to OPEC plus stepping up to cooperate during a period of unprecedented weak demand.
This is a turnaround from earlier this year when a lack of agreement on output levels drove down prices to record low levels.
Over the next six months, demand recovery, and the willingness of OPEC plus to appropriately adapt and match it, will be critical to the trajectory of global oil markets.
The message from OPEC plus so far has been that it will remain committed to market management and the cuts that entail.
Leaders of the group, Saudi Arabia and Russia, have maintained high levels of compliance with announced cuts, and are keeping the pressure on other partners to do the same in order to restore market balance.
This pressure is likely to steer broad compliance moving forward.
OPEC’s Joint Ministerial Monitoring Committee held a virtual meeting in mid-August, restating the organisation’s push to maintain compliance and seek compensation from offending countries.
Compliance is currently at around 94 per cent to 97 per cent of agreed quota targets.
All signs are that OPEC plus members recognise the need to apply sustained pressure around compliance, and ensure the organisation is positioned to manage the long road back to full market recovery.
The reduction of cuts in August, from 9.7 mbd to 7.7 mbd was carefully calibrated, and the group will continue to monitor fundamentals closely in order to adjust as needed.
UNEVEN RECOVERY ACROSS THE INDUSTRY
Despite these efforts, it is undeniable that the oil and gas industry faces a difficult path forward, with some fuels facing particular headwinds.
The outlook is for a strong recovery in the gasoline segment, as drivers seek personalised mobility and safety in their own vehicles. This trend has been witnessed both globally, and in key markets such as China, which finds itself ahead of the international recovery curve currently.
Evolving public attitudes to post-COVID-19 travel suggest that the gasoline recovery will continue.
In the UK, passenger car traffic is back to 90 per cent of pre-lockdown levels on weekdays, and 100 per cent at weekends.
By contrast, public transport on the National Rail and London Underground remain at just 30 per cent of pre-epidemic levels, as commuters continue to avoid crowded and enclosed spaces.
The beleaguered global aviation industry remains a challenge for jet fuel. COVID-19 travel restrictions and the broad economic recession continues to hit the aviation sector hard.
Aviation may not reach pre-pandemic levels for years, as businesses permanently adjust travel policies in the wake of COVID-19.
Diesel demand has also suffered due to reduced economic activity and a fall in cross border trade.
Ultimately, the prospects for demand will depend in part on how the COVID-19 pandemic evolves.
An uptick in new cases, especially in the world’s largest economy — the United States — or a resurgence of local infections leading to more focused lockdowns across Europe would pose renewed downward pressure on oil and gas demand.
In any case, recovery is likely to take time. It took 23 months for global demand to broadly recover from the global financial crisis.
Overall, OECD demand never again achieved pre-2008 levels. The COVID-19 oil recovery is likely to be slower still given the relative depth of the downturn.
Under these circumstances, storage levels are likely to remain high and to supress transacted prices, possibly for years to come.
The 2014 to 2015 storage overhang took roughly three years to clear. Indications remain that with the high storage levels currently experienced, and lingering weakness of demand, this storage overhang may be poised to last twice as long as the previous period.
PRICE PREDICTIONS FOR AN UNCERTAIN RECOVERY
In this era of supressed demand, large supply-cut agreements and historically high storage levels, definitive price predictions remain challenging. Despite this uncertainty, broad consensus by industry analysts is that prices will hover around the US$40 to US$45 level in the near-term.
Rapid demand recovery, complemented by OPEC plus quota compliance, might drive prices higher in coming years.
On the other hand, the impact of second wave infections resulting in further economic shutdowns, or significant breaches of OPEC plus production agreements, could drive prices down further.
In the long-term, oil prices will be more uncertain and remain hinged on the continued cooperation of OPEC plus members.
The impact of the COVID-19 pandemic remains pervasive, with no certainty on when these effects will finally run their course. Analysis of current market expectations would indicate that prices could reach US$60 once more by 2024 to 2025.
Despite glimmers of hope around renewed demand, the global oil industry is preparing for a long and rocky road to recovery ahead.
Dave Sivaprasad is a Managing Director & Partner at Boston Consulting Group, Singapore