Crude perspective on the Oil Market

October 8, 2018

The oil market is not immune to volatility. Over the last 10 years the oil price has swung dramatically in both directions. After the 2008 financial crisis, oil rose 300% from $34 to $126. Five years later it lost 80% of its value when in 2016 it fell to as low as $26 per barrel. Despite the introduction of alternative energy sources, 92% of global transportation remains dependent on oil.

oil market

In 2015 US oil inventories rose dramatically as oil prices fell (see chart). Oil has very complex supply and demand characteristics; there is high level speculation and political sensitivity. There are many different types of oil and uses, which all feed into how the price is derived. Brent is the largest and most well-known global reference for oil prices. Brent is extracted from the North sea and 60% of global crude oil is priced off Brent crude prices. The second and less well-known benchmark oil price is West Texas Intermediate (WTI) extracted from landlocked oil fields in the USA. Despite WTI being a higher quality sweeter oil, it trades at a discount to Brent due to the costly rail transport. Oil pipelines in the US are expected to replace some of the rail transport in 2019. This is expected to reduce the price gap between WTI and Brent. Fragmented sources of oil that span the globe mean there can be multiple factors affecting the price including weather patterns, political influences and transportation constraints. Oil producers are made up of a combination of both private companies and government organizations. Extracting and refining oil is very capital intensive so requires long-term capital investment to handle a complex process of extraction and refinement.

oil market

The top 7 global oil producers supply 50% of the oil market however on the demand side only 3 consumers make up 50%. These three large consumers are the US, Europe and China. The US is the largest global producer of oil and is currently producing over 17.5 million barrels of oil per day. This is followed by Russia at 11.3 million bpd and Saudi Arabia at 10.1 million bpd. Saudi Arabia’s historical dominance in the oil market has been achieved via its membership in The Organization of the Petroleum Exporting Countries (OPEC). The OPEC block of countries currently accounts for 40% of the global oil supply.

oil market

Global oil demand has grown by approximately 30 million barrels per day in the last 25 years. Almost all the growth in oil demand over the last 25 years has come from China and Asia. The Organisation for Economic Co-operation and Development (OECD) countries like the US, Canada, Europe and UK all have almost flat oil demand profiles over the same 25-year period.

Global oil demand is fast approaching 100 million barrels of oil per day and is expected to hit this level by the 4th quarter of 2018. A significant change in the oil industry over the last 8 years can be seen in US oil production. The US has successfully reduced its dependence on other countries by more than doubling its internal oil production and almost closing the gap between its demand and supply.

OPEC and certain non-OPEC producers, including Russia, started withholding oil supplies towards the end of 2017 to end a global glut and prop up prices.

Looming U.S sanctions being imposed on Iranian oil will come into force in Nov 2018. Currently Iran produces 3.8 million barrels of oil per day, which accounts for 3.8% of the global crude oil supply. Certain countries have started to reduce the oil they import from Iran (see chart below). It is anticipated that sanctions will have a limited impact of only 700 000 bpd which is less than 1% of global supply. Saudi Arabia and Iraq do have capacity to fill the supply gap that will be left by Iran but OPEC have not been clear on exactly how they will meet the shortfall. This lack of clarity amongst other things has led to higher oil prices and Brent crude has risen to trade just below $80 a barrel.

Outlook for Oil

Oil demand has historically been robust and during the 2008 crisis demand for oil was fairly inelastic. Unless we see a severe global slowdown or market collapse, global oil demand is expected to continue its growth of 2% per year. The sensitivities are far more evident on the supply side of the oil market. OPEC’s spare production capacity has been in decline and is close to a 12-year low. Production decreases in Venezuela and Iran have been due to political reasons however much of the forecasted production declines for other producers are structural. This is mainly due to old oil fields with high well decline rates. Since 2008 the number of global oil discoveries has been in decline and every year there have been fewer discoveries than the year before. The US accounted for 60% of the growth in global production since 2010. The US is not hampered by the same politics as many of the other oil producing countries and does not have ageing wells. However, the US needs oil prices above $100 per barrel if it is to continue to sustain this rate of production growth. The US pipelines are expected to be completed in 2019 and this could alleviate some of the forecasted supply pressures. While the global supply uncertainties persist, the oil market remains bullish.

Disclaimer: The views thoughts and opinions expressed within this article are those of the author, and not those of any company within the Capital International Group (CIG) and as such are neither given nor endorsed by CIG. Information in this article does not constitute investment advice or an offer or an invitation by or on behalf of any company within the Capital International Group of companies to buy or sell any product or security.

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