It is always difficult to forecast where crude oil prices are heading for the next year or so. However, that said, the world of oil has changed and continues to evolve into one where the price is still being driven by supply. Unlike the past, it is driven by an abundance of supply even with many geopolitical events unfolding around the world.
According to the Institute for Economics and Peace there were just 11 countries (of the 162 they monitor) that were involved in conflict of one kind or another. Had this been the case in early 2008 crude oil prices well may have gone above $147 per barrel—a level that WTI hit in the middle of 2008. Rather, the price of WTI is trading below the psychological $100 level while the spot Brent contract is barely above $100.
Supply trumps geopolitics
As shown in “After the spikes,” (below), even with several geopolitical events evolving around many oil producing regions the spot price of both Brent and WTI have been in a slowly declining triangular consolidation pattern since 2011. Going forward there are no signs that suggest the price of oil is likely to change course. Rather, expect more of what we have seen over the last several years with a slow growing bias to the downside.
Why is this? Let’s start with supply. Yes there are many interruptions in crude oil flow around the world. “Stopping the flow” (below) shows that interruptions in oil supply from both OPEC and non-OPEC countries have been increasing steadily since 2011, yet crude oil prices have been stable and actually in a slight declining pattern as shown in the first chart. Combined interruptions in oil supply were running about 3.2 million barrels per day (BPD) in July 2014 (latest EIA data point as of this writing).
During any time prior to 2008 this situation would have been met with strong buying from both the commercial and non-commercial sectors of the global oil industry. Currently it is being met with a bit of a yawn as U.S. supply has changed the market sentiment significantly over the last four or five years.
The single major change in the world of oil has been the exploration and production revolution taking place in the United States and Canada over the last five years. While Canada has contributed to the increase, U.S. production has been a game changer. “A new ball game” (below) shows the total U.S. and Canadian crude oil and liquids production going back to 2007. The table embedded in the chart compares production levels going back to 2011 to be consistent with the previous chart which shows the OPEC and non-OPEC oil supply interruptions.
Since January 2011 total U.S. production has increased by 4.46 million BPD while Canada gained 0.85 million. Combined, the increase is 5.32 million or a little over 2 million BPD above what has been shut in by both OPEC and non-OPEC countries combined. This is the major reason why oil prices have been in a downward sloping consolidation pattern since 2011.
The additional U.S. and Canadian production has translated to a reduction of about 2.1 million BPD of non-Canadian imported crude oil into the United States, an increase of about 350,000 of crude oil exports (just the start) and an increase of 1.1 million BPD of refined product exports, all since 2011. These changes combined equal about 3.55 million BPD of crude oil that has been put into the international market since 2011 as a reduction in U.S. crude oil imports has the same impact as exports because those barrels that were being imported to the United States are now heading elsewhere.
The 3.55 million BPD of additional movement of oil from the United States into the international market has more than offset the loss of OPEC and non-OPEC crude that currently has been removed from the international market, with the remaining additional U.S. crude oil production filling incremental U.S. refining capacity and contributing to the growing refined products export business (now more than 3.2 million BPD).
Thus the journey back into history helps explain the reason why oil prices are carrying a relatively low geopolitical risk premium and one that is well below levels experienced in the lead up to the price peak in the first half of 2008. The U.S. crude oil revolution, buoyed by that price spike, is now growing on all fronts.
What about demand?
As we look to the next year or so, understanding the historical backdrop and how it is impacting the global supply side of the equation is very important. The demand side of the equation has been growing over the last five years but not enough to offset supply growth, even with the evolving geopolitical events.
EIA data shows global oil consumption has grown by 4.61 million BPD since the end of 2014, or about 0.7 million BPD less than total U.S. and Canadian crude oil and liquids supply grew combined. Overall global supply has increased by 4.95 million BPD over the same time frame. The oversupply situation is a bit understated, as about 3.2 million BPD of OPEC and non-OPEC oil is still shut in for various reasons. If this oil were being produced the price would be much lower.
The majority of the oil demand growth that has occurred over the last three or four years primarily has been from developing world countries and not OECD countries. This pattern is expected to continue into the foreseeable future as Europe’s economy remains sluggish at best while the U.S. economy is picking up but it is still growing at slower than the historical rate. Global oil consumption is projected to grow by about 1.4 million barrels-per-day in 2015 (August EIA Short-Term Energy Outlook) with the United States representing just 93,000 of this growth even with the U.S. economy starting to perk up. Simply put supply continues to outstrip demand.
How should this historical backdrop guide our view of supply, demand and price? Let’s start with supply but this time focus on what could change over the next year or two, both from an upside and downside supply perspective. The major supply hotspots to watch over the next year or so are: The United States, Canada, Iran, Iraq, Libya, Russia and Saudi Arabia.
These countries will have the largest impact on oil supply through 2015 and thus the largest impact on price. Certainly U.S. and Canadian production will continue to increase during the next year or so, with the main limitations for both being infrastructure and legal limitations on exports (U.S. only). Canadian production is expected to grow only marginally as the United States is close to maximizing out on the amount of heavy Canadian grades they will be able to move into the U.S. system with incremental movements still relying on rail transportation as pipelines max out quickly.
U.S. production is expected to grow by about 1.1 million BPD in 2015 or about 85% of the total global oil supply growth. This should translate into a decline in U.S. imports in 2015 coupled with U.S. refinery run rates likely at the highest levels of any refining region of the world as the U.S. maximizes its refined products export business.
At the moment the United States is only exporting about 385,000 BPD of crude oil (mostly to Canada) with condensate from the Eagle Ford producing area starting to dribble out into the export market. As of this writing only three cargoes of condensate have been exported from the U.S. Gulf Coast (all to Asia) as the U.S. Department of Commerce considers additional applications. Blanket exporting of crude oil is not likely to change over the next year or so, but additional exports of crude oil and condensates will increase slowly as the political process evolves with the possibility of ending the ban on crude oil exports. Overall the U.S. and Canadian impact risk to supply is to the upside through 2015.
Both Iran and Libya also are likely to be an upside risk to the international supply market as the odds of Iran negotiating a nuclear deal with the West by the mid-November deadline have increased over the last few months. To the extent that a deal is done and the sanctions are lifted Iran will quickly begin to increase its crude oil export levels over the course of 2015 as its economy remains in a shambles since the onset of sanctions.
Iraq is a different situation but one that currently is expected to maintain its current production level even with the fighting going on in the north. The majority of the oil supply is in the south of Iraq and so far ISIS has not ventured south. In addition the United States and the West have demonstrated a desire to get involved in Iraq cautiously. Expect much more involvement if oil supply is jeopardized by ISIS. Iraq production should be steady but with geopolitical risk in 2015.
In spite of the chaos that still exists in Libya, production is growing. As of early September, production is back to about 700,000 BPD, according to the National Oil Company, the highest level in a very long time. Libya currently is looking like an upside risk to supply but one that can turn at any time over the next year or so. If production continues to increase it will put additional high quality oil into a market that does not need it right now.
Russian oil supply is viewed as steady at this point, even with all of the fighting going on in Ukraine. Ukraine is a natural gas issue not an oil one. The effect to oil supply can come only if the West issues strong sanctions that are directly tied to Russian crude oil exports. That is doubtful as the supply exposure to the Europeans is greater than the benefits they would likely get from the type of sanctions required to have a significant impact on Russian oil exports.
Last but not least is Saudi Arabia. There are two exposures coming from Saudi Arabia, both presenting a risk of a supply reduction. There is always the geopolitical risk to Saudi supply, especially with ISIS and al Qaeda active in the Middle East. On Sept. 2, the market got a little reminder of this exposure as a Saudi pipeline was hit with gunfire, causing a small fire with no impact on supply.
In addition, Saudi Arabia is the incremental OPEC producer, and if Iran and Libya and other OPEC countries continue to increase supply, the Saudis are likely to reduce exports as OPEC begins a price decline defense strategy. Saudi Arabia and OPEC can be expected to continue this strategy throughout 2015.
Overall supply should outstrip demand for the next year or so with crude oil prices remaining in a slightly downward pattern. That said, this is a cautious expectation as there is still a significant amount of geopolitical risk that can change this view very quickly. The demand side of the equation will be a neutral for oil prices with the overall oil complex primarily being impacted by the supply side and geopolitical concerns.