IEA warns 'limited headroom' to absorb supply amid demand uncertainty

London — The oil market has only limited capacity to handle extra supply in the coming months given Libya's potential production increases, OPEC+ continuing to ease back its quotas, and the uncertainty over demand, the International Energy Agency warned Oct. 14.

The Paris-based agency kept its oil consumption outlook largely unchanged, predicting demand will fall 8.4 million b/d in 2020 but rise to 5.5 million b/d in 2021. That compares with S&P Global Platts Analytics' view of a demand drop of 8.3 million b/d this year and a 6.2 million b/d gain next.

However, the IEA pointed out that "the trajectory for COVID-19 infections is strongly upwards," which "surely raises doubts about the robustness of the anticipated economic recovery and thus the prospects for oil demand growth."

The oil market is still trying to digest a huge stock overhang from earlier this year and while inventories are decreasing, there is still a long way to go. The IEA sees a "significant" stock draw of 4 million b/d in the fourth quarter but noted this is "happening from record high levels."

Platts Analytics said global stocks have shed more than 200 million barrels since their peak but that still leaves inventories over 600 million barrels above pre COVID-19 levels. "The stock draw have paused for now but should be resuming for 2021 depending on the demand response and winter temperatures," Platts Analytics said.

SUPPLY RISKS

While the coalition between OPEC, Russia and other oil producers has helped bring some stability to the oil market, with its record production cut deal of almost 10 million b/d earlier this year, the pact is now unwinding gradually from the steep reductions. Oil prices have steadied around $40/b but with demand still fragile, the IEA noted the "limited headroom for the market to absorb extra supply in the next few months."

OPEC+ plans to bring an additional 1.9 million b/d to the market in January 2021, and a look at the forward curve shows oil prices not reaching $50/b until 2023, the IEA said, signaling the difficult journey ahead for the industry.

Complicating rebalancing efforts is the return of Libyan crude production. The North African country has seen production rise to 300,000 b/d recently after a ceasefire between rival factions, and the IEA sees output climbing to 700,000 b/d by the end of the year.

While the oil market may have some skepticism whether the truce in Libya will hold, given the fragility of deals struck in the past, the IEA said assuming the agreement sticks production will gradually recover to the 1.2 million b/d seen before the eight-month blockade.

Libya is exempt from the OPEC+ deal and its output recovery lies in stark contrast to the compliance and discipline shown by fellow OPEC members. A sharp supply cut from the UAE helped boost overall OPEC+ compliance to 103% in September versus 98% in August, according to the IEA, with all key producers apart from Russia pumping at or below their targets. However, the UAE, Iraq and Russia still have to make up for their under-compliance, according to IEA estimates, which could help dampen the additional Libyan flows.

Meanwhile, the production outlook for storm-hit US remains downbeat. The IEA sees US crude oil production falling in both 2020 and 2021 to average 11.35 million b/d in 2020 and 10.8 million b/d next year.

The agency reiterated that current activity levels were still too low to sustain a substantive recovery in onshore oil production, with operators likely drawing down their inventory of drilled but uncompleted wells.

The US scenario may provide some room for OPEC+ to continue unwinding its deal, but with Libya and demand weakness in the mix, the goalposts continue to shift.