Global oil demand could leave gaping hole: Fuel for Thought

Global oil demand growth was a much heralded sidekick to supply cuts that rebalanced the market in record time. Now the Saudi Arabia-Russia pronged pact is considering reversing course on its output cut deal, while demand growth shows little sign of letting up.

That risks leaving a hole in the market that the OPEC alliance will struggle to plug.

Oil bulls listening to Jeff Currie, Goldman Sachs’ head of commodity research, at the S&P Global Platts Crude Oil Summit earlier this month would have been rubbing their hands with glee. He stated he was his most bullish in a decade.

“The underlying demand trend is what is dominant here, not the OPEC production cuts. That is secondary,” Currie said.

OPEC and 10 other countries embarked on a plan to remove 1.8 million b/d in late 2016 to wipe out a more than 300 million barrel stock overhang. And that mission has been accomplished well ahead of the deal’s expiry at the end of year, thanks to over-compliance to the cut quotas and a healthy appetite for crude.

It’s an appetite that has been called into question at higher prices. But a look at the forecasts from major institutions such as the IEA, IMF and S&P Global Platts Analytics shows that the consensus is that demand is set to remain robust.

“Demand continues to be healthy on the back of strong economic growth. However, with higher oil prices we are seeing some signs that demand is softening slightly by 100,000-200,000 b/d,” said Chris Midgley, head of Platts Analytics.

“In the short term, price should have a relative small impact on demand. But if commodity prices remain elevated, we could start to see this have a drag on global GDP growth — with signs of concerns in places like Turkey and Brazil for instance — which could have a far greater impact on overall demand growth,” Midgley added.

NEAR-TERM DEMAND ROBUST

Currie downplayed the risks of demand destruction at close to $80/b in the near term at least.

“A lot of people are concerned about higher oil prices and their impact on demand. The evidence really isn’t there,” he said.

Saudi Arabia and Russia have discussed the possibility of raising production quotas as early as the third quarter of this year, but will need to convince the rest of the coalition, not least Iran.

Due to US sanctions kicking in in November, OPEC’s third-largest producer faces losing further market share to a select group able to raise production fairly quickly: namely Saudi Arabia, UAE, Kuwait and Russia.

How much they can raise has been a moot point and would be severely tested going into the summer when Middle East producers need to burn more crude.

While some OPEC watchers aren’t convinced that the group will bring in specific new quotas, it appears the alliance may need to do more than just signal greater flexibility to the deal. That’s irrespective of pressure from heavyweight consumers such as the US and India, which have both voiced their concern over higher prices in recent months.

PLAYING CATCH-UP

Talking of speculation around a 1 million b/d increase, Currie said: “The market needs the extra supply. It not only needs it, it’s mandatory. Otherwise you just drive the bus off the cliff.”

“Global demand is 100.5 million b/d and supply is running around 99.5 million b/d. So you got 1 million b/d gap…which means something’s gotta give. Either you’ve got to see a lot higher prices, which is inflationary, or more supply and OPEC is the only one with spare capacity,” Currie added.

And the longer OPEC sits on its hands, the wider the gap becomes as Venezuela output continues to crumble and oil demand races away. Moreover, the metrics that point to a tighter market also lag a couple of months behind, suggesting there is already ground to be made up.

A look at OPEC’s May report also highlights the challenge.

Global demand for OPEC crude will average 32.74 million b/d in 2018, OPEC estimated, down 260,000 b/d from 2017.

That compares with OPEC’s April production of 31.93 million b/d, as estimated by independent secondary sources that OPEC uses to monitor output.

Many in the industry point to US supply and other non-OPEC production such as Brazil and Canada as offsetting the 1.65 million b/d that OPEC forecasts demand will grow by this year. That would suggest OPEC may not need to press the panic button.

However, that omits the fact that a lot of that extra crude comes from US shale which is much lighter and sweeter than much of the OPEC lost barrels that are heavier and sourer. It is not a like-for-like substitute and complicates the rebalancing picture.

“Between now and the end of the business cycle I definitely want to be long oil,” Currie said, pointing to the next 18 months.

If Russia and Saudi Arabia need to convince the rest of the coalition that quotas need to be adjusted when they meet in Vienna on June 22, demand should be top of the list before the cyclic nature produces a more volatile market by itself.