Excess supply, economic fears drive down oil prices

  • Russian Minister of Energy Alexander Novak, center right, Saudi Minister of Energy, Industry and Mineral Resources Khalid al-Falih, center, and OPEC Secretary General, Mohammed Sanusi Barkindo, center left, are surrounded by reporters during the opening of a meeting of energy ministers from OPEC and its allies to discuss prices and production cuts, in Jiddah, Saudi Arabia, on May 19, 2019. Saudi Arabia has led the 14-member alliance in production cuts, but supply is continuing to outpace demand and holding prices down. (Photo/Amr Nabil/AP)

Fears of an oversupplied oil market amid rising global trade tensions are holding down prices. In addition, markets are reacting to weak economic indicators and unsettling political news, along with rising non-OPEC production, resulting in frequent daily price swings of $2 or more per barrel.

Worries of too much oil chasing after uncertain demand is making investors, traders and corporate executives nervous, even prompting one bank to suggest prices could drop more than $20 a barrel if everything goes wrong.

“Oil is at the edge of a cliff,” analysts at Bank of America Merrill Lynch wrote in a research note.

Brent, the global price, started the week of Aug. 26 at around $59 per barrel, off more than 20 percent from its April peak of $74. U.S. crude tumbled roughly 8 percent on Aug 1, the steepest one-day drop since 2015, after President Donald Trump announced a new round of tariffs on China.

“President Trump’s unexpected tariff announcement … suddenly revived the specter of an economic slowdown, akin to bubonic plague for oil demand,” Robert McNally, president of Rapidan Energy Group, told The Wall Street Journal in early August.

“The U.S.-China trade spat has been at the center of the oil market demise, which has sent the global economy to the brink of recession and negatively impacted oil demand forecasts,” Stephen Innes, managing partner at VM Markets, Singapore-based trade specialists, was quoted by Reuters on Aug. 20.

“Recession risk is now the single biggest factor driving oil prices because it will determine whether recent price falls will be enough to rebalance the market, or whether a deeper and longer slump is needed,” a Reuters’ columnist said Aug. 20.

Putting numbers to the risk, a Bank of America Merrill Lynch global research report warned Aug. 2 that prices could sink more than $20 per barrel if China decides to buy Iranian crude in retaliation for U.S. trade tariffs.

“A Chinese decision to reinitiate Iran crude purchases could send oil prices into a tailspin,” the report said, noting that the increased volume would add to an already well-supplied market.

Global oil consumption is falling at the fastest rate since late 2014 as manufacturing and trade flows slip and as production of new cars and trucks declines, the Reuters’ columnist reported. Demand in the top 18 consuming countries fell by almost 0.2 percent in the three months between March and May compared with the same period a year earlier.

Back in 2014-16, the combination of falling consumption with booming U.S. shale output and Saudi Arabia’s refusal to cut back on its production led to a price slump that dropped Brent from the $100-plus level in 2014 to a low of $27.88 in January 2016. This time around, Saudi production cutbacks have limited the price drop.

OPEC is trying to prop up prices. Total output by its members hit an eight-year low in July with a further voluntary cut by top exporter Saudi Arabia.

The 14-member Organization of the Petroleum Exporting Countries pumped 29.42 million barrels per day in July, according to a Reuters survey, the lowest OPEC total since 2011.

But despite the cutbacks by OPEC and its allies, “bulging global oil stocks have failed to decline and the market remains well supplied,” said Stephen Brennock, with PVM Oil Futures, which bills itself as the world’s leading broker of oil trade and investment instruments.

OPEC, Russia and other non-members agreed in July to continue their voluntary cutback in production, extending the deal adopted in December. The producing nations agreed to trim their output by more than 1 million barrels a day, about 1 percent of worldwide production.

Even with that, OPEC has indicated the market will be in slight surplus in 2020.

“The risk to global economic growth remains skewed to the downside,” said an OPEC report of early August.

OPEC may be able to govern its own production to guard against global oversupply and low prices, but U.S. producers continue driving much of the surge in output, along with new projects in Brazil and Norway. Citigroup and JPMorgan Chase analysts project global supply will grow roughly 1 million barrels per day more than demand in 2020.

The analysts said those new barrels could exacerbate the expected global surplus, particularly as concern about a slowing world economy triggers fears about crumbling demand.

U.S. production totaled 12.3 million barrels per day in June, setting a new record. The nation’s output was just 5 million barrels per day in 2008. The U.S. Energy Information Administration forecasts 13.3 million barrels per day in 2020.

Much of the booming production is coming from Texas, in particular the Permian Basin. Oil production in Texas has shot up from about 1 million barrels per day a decade ago to 5 million this summer.

All that oil needs buyers, and much of it is leaving the country — but not as much as earlier in the summer. U.S. exports averaged 2.4 million barrels per day during the three-week period ended Aug. 9, down from an average 3 million barrels between the start of May and mid-July, Energy Information Administration figures show.

It was easier to sell U.S. crude overseas when it was priced about $8 to $10 per barrel less than Brent, as it was over the winter and much of the spring. But U.S. oil is now trading at the smallest discount to global prices in more than a year.

New pipelines are transporting oil from the Permian to the Gulf of Mexico, easing the bottleneck that constrained markets and held down prices. With improved access to overseas buyers, West Texas Intermediate crude was trading at just $3.50 less than Brent the third week of August.

Higher prices reduce the attractiveness of U.S. crude exports.

“Nobody really wants the barrels when they’re $3 cheaper than Brent,” Bob Yawger, director of the futures division at Mizuho Securities USA, was quoted by The Wall Street Journal on Aug. 20. “It could get ugly long term.”

Larry Persily is a former Alaska journalist, state and federal official who has long tracked oil and gas markets and projects worldwide. He is the incoming Atwood Chair of Journalism at the University of Alaska Anchorage School of Journalism and Public Communication.

Updated: 
08/28/2019 - 10:05am

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