Why oil price recovery has further to run

Does this latest downturn underpin belief in ‘lower-for-longer’ oil prices or will it prime a new cyclical uptick? A case can be made for both. We published our latest Macro Oils long-term outlook to 2040 last week. Today, the market is fretting about weak demand. Ann-Louise Hittle and her Macro Oils team argue that lost supply is the bigger concern and will lead to a tighter market.

Is oil demand recovering?

Yes. Demand has taken a brutal hit from coronavirus, falling an astonishing 21 million b/d year-on-year in April on our estimates. But we’re already into the early stages of recovery and the outlook is promising as China, the US and Europe emerge from lockdown. Gasoline demand is bouncing strongly. Jet fuel will be much slower, with global flight activity suppressed by restrictions on travel and dulled consumer appetite.

What does demand look like in 2021?

We expect a significant increase on the back of a recovering global economy, and assuming no second waves of coronavirus. We’re forecasting liquids demand to average 99 million b/d in 2021, a 6 million b/d jump from 2020. That would take global demand almost back on a par with 2019; but still 3 million b/d below our pre-crisis forecast for 2021.

Has the crisis structurally changed consumption?

To a degree. Among the changes we’ve incorporated are a shift away from public transport, boosting demand from light vehicles, increased online deliveries supporting road freight and reduced jet fuel demand, which never returns to our pre-crisis forecast right through 2040.

Will new policy accelerate the energy transition?

We explored three scenarios last month which highlighted risks to oil demand, including a ‘greener growth’ scenario. We’re already seeing policy intensify in a few countries as a direct result of the crisis, with some cities, for example, intending to tighten existing restrictions for vehicles to enter city centres.

More broadly, policies to tackle environmental challenges are already the primary mitigating force restraining long-term oil demand. But even if we do see these ramped up beyond current expectations, any material effect on demand is more likely next decade than in the 2020s.

So where will oil demand be in 2025?

We reckon it will gain about another 5 million b/d from 2021 to 2025 and stand just 1 million b/d below our pre-crisis forecasts. Our thesis is that the global economy is still heavily dependent on oil; there’s no ready alternative. At the same time, there are irrepressible secular drivers of demand. Rising global population growth, GDP growth and the expansion of the middle class will reassert themselves in the next few years and drive demand to new highs.

How has supply been affected?

The impact from current low prices looks more severe and more lasting on supply than on demand. Companies withdrew capital very quickly in reaction to lower prices. Investment will remain low into 2021 and beyond as the industry looks to preserve cash and repair balance sheets. Our new Macro Oils long-term outlook shows big downgrades in the next few years, with global liquids supply down by 4 million b/d each year through to 2025.

Where has supply been hit?

Most of the reduction is to non-OPEC, and the bulk of that in the US Lower 48. US liquids production increased by almost 10 million b/d in the last decade; volumes are likely to be flat through 2022, and any growth thereafter incremental and price-dependant. Future OPEC supply will also be affected by lower investment (Angola and Nigeria) and increased political uncertainty (notably, Iran, Libya and Venezuela).

Does this mean higher prices?

We certainly think Brent under US$40/bbl is unsustainable. With supply falling and demand recovering, we’ll see the market tighten, increasing the risk that price will move sharply higher into the mid-2020s. We’ll need new investment in supply where the cost of the marginal barrel is US$60 to US$70/bbl.

What are the risks to our analysis?

There’s a lot of uncertainty – both downside and upside risks. Among these are the pace at which the global economy recovers, a sustained second wave of Covid-19, geopolitics and the cohesion of OPEC and OPEC+, and policy, including on the environment. Then there are supply fundamentals such as efficiency improvements through new technology and, importantly, corporate behaviour.