It is very hard to see how oil prices can rise significantly in the short term.” For oil prices, the “short term risk to the downside has increased.”
Those were the conclusions from the IEA’s February Oil Market Report. On the heels of the plunge in oil prices to $26 per barrel, the IEA sounded a lot more somber since it last issued its monthly assessment.
The Paris-based energy agency ticked through all the key potential drivers that could push up oil prices this year, knocking each one down with a renewed sense of pessimism.
The first potential source of bullishness, and the most tenuous, was the possibility of a production cut from OPEC and a few major non-OPEC countries. The IEA dismissed the rumors as mere “speculation,” saying that the “likelihood of coordinated cuts is very low.” Given the seemingly failed bid by Venezuela’s oil minister to secure a more forceful pledge from Saudi Arabia to push an emergency OPEC meeting over the weekend, the hype over coordinated reductions from some of the world’s top producers seems increasingly remote.
Even if OPEC decides not to slash output, another hope for the oil markets is the prospect that the cartel will at least fail to increase production. Lower oil prices have cut into the revenues of all OPEC member countries, and in places like Iraq, that could directly affect the country’s ability to continue to ramp up output. It is still too early to tell if things will play out this way, but the latest figures from OPEC do not bode well. Iraq achieved record production in January at 4.35 million barrels per day (mb/d). Iran increased production by 80,000 barrels per day (bpd) and still has room to grow. And although Saudi Arabia probably won’t continue to ratchet up output through 2016, preliminary data suggests that the oil kingdom increased output by 70,000 bpd last month, according to the IEA. As a result, shrinking, or at least flat production from OPEC, is not a given.
So, a supply-side adjustment will come from U.S. shale, right? U.S. shale production has slammed on the breaks after years of blistering growth, and output is down to about 9.2 mb/d, off 400,000 bpd from the April 2015 peak. The EIA sees output falling to 8.7 mb/d this year, shaving off another 500,000 bpd. But the IEA doesn’t see huge cuts coming, reiterating its prediction that total non-OPEC production, which includes the U.S., will fall by only 600,000 bpd this year. “Perhaps resilience still has some way to go,” was how the IEA summed up the situation.
The strength of the U.S. dollar was a very large driver of the oil price crash, a factor that was probably underemphasized over the past year. The Federal Reserve’s plans to hike interest rates, along with concerns over the stability of the global economy, has driven up the strength of the dollar. Even if the Fed pulls back from its planned rate hikes, which looks more likely than it did in December when the central bank initiated its first rate increase, the dollar will maintain its strength because of its attractiveness as a safe-haven during times of uncertainty. As a result, the IEA doesn’t foresee a sizable depreciation, removing another driver of bullishness for oil prices.
On the demand side of the equation, the IEA merely reiterated its call for demand to grow by 1.2 mb/d this year, unchanged from previous predictions. That is down substantially from the 1.6 mb/d the world saw in 2015. While that may still be a “very respectable rate,” the IEA doesn’t believe that the cheapest oil in over a decade will spur stronger consumption.
What does all of this mean for oil prices? The IEA sees a larger surplus now than it previously anticipated. Excess supply of about 2 mb/d will persist through the first quarter, which will fall to 1.5 mb/d in the second. The glut should shrink to 0.3 mb/d in the second half of the year, but with storage levels still rising, oil prices may not rebound by much.
Separately, Jeffrey Currie, the head of global commodities research at Goldman Sachs, said on February 9 that oil price volatility, already at multiyear highs, will probably increase in 2016 and that he wouldn’t be surprised if oil dipped below $20 per barrel. Goldman has made a name for themselves with their bearish predictions on crude oil – and many of them have largely come to pass.