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Oil
December 17, 2017
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Oil

The outlook for oil prices

Comment
Oil prices are falling as the market deals with an ample supply and a weakening economy.

Oil prices plunged this spring as the market reacted to worries about a deepening euro-zone crisis and a weakening global economy. While we expect the euro zone to remain intact, the likelihood of Greece's exit has grown. Such an outcome would further dampen world gross domestic product (GDP) growth and, in turn, decrease demand for oil.

At the same time, oil supply has been ample, allowing the market to feel more comfortable with a reduction in Iranian oil exports due to the recently imposed U.S. and European Union sanctions against the country. Market anxiety over a major supply disruption—particularly in the Persian Gulf—has also eased. Indeed, the recent price decline has diminished—at least for now—the "Iran premium" that had been built into prices.

Oil prices might now be seen as resuming the decline that began in the second half of 2011. That downturn was briefly interrupted by what appears to have been excessive optimism over steps to quell the euro-zone crisis and by a period of escalating tensions between Iran and the West.

The growing pessimism about the global economy is a reflection of the recent shift in the market's expectations regarding oil's fundamentals. This shift is warranted. Economic growth is a key factor in demand growth for oil. We have been projecting weak demand growth for oil in 2012—an increase of about 700,000 to 800,000 barrels per day (bd). Our 2013 outlook for a gain of 1.05 million barrels per day (mbd) is at risk of being revised downward.

Into the "Vortex"?
Recent developments mean the risk of a so-called "Vortex Scenario"—a long economic slowdown and much lower oil prices—is again rising. In this scenario, a euro-zone disruption triggers a collapse of economic growth in the United States, China, and much of the rest of the world, and the following occur:

  • Unlike during the Great Recession of 2008–09, the governments of the United States and Europe don't have the fiscal or monetary firepower to revive their economies.
  • Emerging markets are unable to offset a sharp fall-off in demand from developed countries with demand from one another.
  • China, which unleashed a massive stimulus during the Great Recession, is unable to productively absorb a similarly large dose of government spending, owing to industrial and infrastructure overcapacity.

To be clear, we do not consider Vortex to be the most likely scenario for the future, but the risk that it will develop has grown.

Meanwhile, Saudi Arabia, the kingpin of the Organization of Petroleum Exporting Countries (OPEC), has been publicly explicit about targeting a price of US $100 a barrel for Brent crude (one of two oil-industry price benchmarks). Because Saudi Arabia has significantly raised output since late last year to meet demand and help curb runaway prices, it will come under pressure from other OPEC members, who will expect Riyadh to trim its production if prices fall to $90 or less for Brent crude oil. Of course, Saudi Arabia may decide to start trimming its output well before that if demand for its oil slackens.

But if concerted action is needed to sharply reduce supply—that is, if prices start falling fast in an oversupplied market—then OPEC will have to reopen the contentious issue of assigning output targets to individual countries.

Whatever the case may be, one thing is certain: A rocky road is ahead for the oil market.

Jim Burkhard is the managing director of IHS CERA's Global Oil Group.

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