In the wake of the COVID-19 pandemic and subsequent oil price war, world oil supply and demand continue to fall victim to price volatility and wavering investor sentiment. Surging production, storage shortages and falling oil prices have spelled deep trouble for the oil and gas industry.
This intertwined relationship of geopolitics, economics and energy requires a delicate balance by governments, operators, and investors around the world. We'll explore the factors impacting global oil supply and demand and the pace of recovery. Besides, we'll review key oil and gas industry initiatives, such as, did the pandemic accidentally force the industry to push cost cutting digital transformation initiatives forward? How might stakeholders and operators continue to expand the role of renewables and clean energy?
By monitoring the key indicators of oil supply and demand, such as oil rig counts and activities, the energy investment outlook and crude oil price forecasts, our team of experts will share market intelligence to guide your strategic decisions.
Oil at $80 sows the seeds of volatility in supply and demand
As markets approach normalization, higher prices breed reactivity in fundamentals, with supply gradually eclipsing the demand story
- After the demand surge. Oil markets are objectively in a good place with a clear path towards structural tightening for the first time since the 2014 crash. Physical market tightening picked up pace as the vaccine-induced global crude oil demand recovery delivered on its promise and OPEC+ stuck to its leading from behind mantra. Exploration & production’s (E&P) capital discipline and a delayed Iran return did the rest, drawing down stocks, lifting prices, and steepening backwardation. Oil prices found support above $70/bbl, and as markets have tightened, calls for a looming supercycle have now seemingly become consensus. But recent weeks show the path to higher prices from here is neither linear or guaranteed, with higher prices breeding instability and volatility on both sides of the balance’s ledger.
- Too much of a good thing? As prices have flirted with $80/bbl, crude oil markets got a glimpse of the challenges that come with higher prices, both for supply and demand. Higher prices are inducing responses from producers in North America, within the OPEC + confab, and from consumers as well as the broader economy. The strategic divergences within the OPEC+ construct were put on full display in recent weeks even as a compromise was achieved. The financial rehabilitation of the US E&P sector has been turbo-charged, facilitating the path back to growth, even if more muted by stickier commitments to returns. Beyond the COVID variant-induced oil demand headwinds, major consumers the world over have also started to express unease with higher prices, with mainland China in particular able to materially undermine physical markets if it seeks to limit costly overheating. We believe these are critical signs that oil prices will encounter more meaningful resistance as the global supply picture becomes more dynamic over the next six quarters. If 2021 was the year of the post-COVID global oil demand recovery, 2022 will be the year of the post-COVID global oil supply reckoning.
- Testing the sustainability of the price band. Entering the spring demand surge, we described the price environment as more likely to see a consolidation at the higher end of the $60-$75/bbl range than a relentless transition into a new, higher, band. To paraphrase our 2Q2021 Outlook, we maintain that prices above $70-75/bbl over a quarter or more sow the seeds of their own destruction, as supply discipline slippage overwhelms even the stout demand recovery. We are now at that critical pivot point. As we look at both the responses to higher prices over the past month and global balances in 2022 as the demand recovery decelerates, we continue to see limited catalysts for sustained upside above current levels unless Iran talks fall apart. Momentum has carried us this far, making it hard to bet against it, but we believe the next level will need the physical tightening to significantly accelerate, and especially the normalization of spare capacity. Without clear evidence of both a supply squeeze (draws + low spare capacity) and supply inelasticity (over two quarters), prices above $80/bbl do not appear to be sustainable.
- Tempting fate: Supply anxiety or supply complacency? The tightening of world crude oil markets and drawdown of the historic 2020 surplus are certainly worth highlighting, but somewhere along the lines an aggressively managed rebalancing has been conflated with an organic recovery. The supply complacency that was allowed to take root since last fall will be tested in 2022. In our view, this process will help recalibrate market expectations and prices entering the medium-term.
Cruising altitude: Physical tightening hits top of the price band
Momentum has nudged prices higher, but global deficits may be at their peak with no change to structural price determinants in 2022
- Short-term momentum pushes 3Q2021 prices higher, but we see no catalyst for a revision to our 2022 outlook. As a result of recent upside pressure and physical indicators, we have lifted our outlook for 3Q2021 prices by $5/bbl for Brent and $4/bbl for West Texas Intermediate (WTI), to $74/bbl and $71/bbl, respectively. However, we see no material changes thus far in fundamentals, paper markets, or geopolitics that would undermine our structural view of the sustainable price environment in 4Q2021-2022, with our 2022 outlook unchanged at $66.25/bbl for Brent and $62.75 /bbl for WTI.
- Potential risks to the outlook: demand disappointment, OPEC+ discord, and Iran-US fallout. For prices to breach out of the current $65-$75/bbl range, significant changes to the trajectory of fundamentals in 2022 and beyond would have to become visible. On the downside, the two obvious risks to the outlook are that virus variants overwhelm the global vaccination campaign, reversing demand gains, and that OPEC+ disagreements boil over into a collective market share push. Both of these risks remain low likelihood in our view but would have an outsized impact on prices by upending two core assumptions of the rally to date: the COVID-19 demand crisis is in the rear-view mirror and OPEC+ is cautiously managing the return of spare capacity. On the flipside, the major source of upside risk would be a breakdown in US-Iran talks that would indefinitely delay the return of Iranian oil to the market, enabling OPEC+ to unwind spare capacity faster. Finally, there remains a great deal of uncertainty on the extent to which the US unconventional engine restarts given reflating oil and gas prices, with enduring restraint liable to feed price upside while a robust rebound (350,000+ b/d per quarter) could severely pressure prices, with both sets of outcomes currently still on the table given the scale of cash flow surpluses.
Chart 1: Outlook for global crude prices
Draws roll on in 4Q21 - 2022 balances reflect a more delicate dance
- Short term tightening to endure, but 2022 looks less clear cut. The relative slowdown in the rate of tightening in the first quarter gave way to a sharp acceleration in draws over the second quarter, despite the collapse in Chinese crude imports. Even with OPEC+ producers continuing to ease curbs through the end of the year, we expect sustained draws through 4Q2021. However, the deceleration in the rate of global demand growth heading into 2022 means that the effective increase in the call on OPEC (or OPEC+) will be limited next year, even without factoring the potential impact of Iran’s return, creating a potential return to stock builds as spare capacity unwinds.
Key balance assumptions and revisions from last quarter:
- Tightening balances give way to more breathing room in 2022 as supply returns. The unwinding of global spare capacity has started to play out but the likely easing of sanctions on Iran has been pushed out as a new administration takes over in Iran. High prices will likely lead to higher 2022 supply from both the US and OPEC+. We have revised our supply expectations for 2022 upwards relative to our April outlook by 0.7 MMb/d, with revisions concentrated in the back half of the year. Prices are creating a dynamic element in the supply picture, with ~$65/bbl the price needed to keep forecasts in shape.
- Global demand recovery plays out according to plan. Variants and slow vaccination outside of developed markets limit upside scenarios. The odds of a swift boom in “pent-up” demand above 2019 seem less likely. We have lifted our 3Q2021 global demand outlook by 0.3 MMb/d to 99 MMb/d, now 6.6 MMb/d above 1Q2021 levels. We have maintained our expectations for 2022 demand levels to average 101 MMb/d, in line with 2019 annual average levels, with 2H2022 to exceed 2H2019 levels by 0.9 MMb/d on average.
- Tightening balances give way to more breathing room in 2022 as supply returns. The net impact of the revisions to our demand and supply outlooks is a net tightening of global balances of 0.3 MMb/d in 2H2021 but a marked loosening of 0.7 MMb/d in 2022 relative to our April outlook. We expect liquids inventories to draw through the end of the year. In our base case, we see stocks building materially in 2022 should OPEC+ cuts unwind continually, supporting our view that the market is set to enter a critical consolidation phase as demand decelerates and markets gauge the real post-spare capacity supply fallout.
Chart 2: World oil (total liquids) demand and production
Chart 3: Revisions to global supply and demand vs. April 2021 outlooks
US crude oil at the heart of global deficits
- Perfect storm strikes US crude storage tanks The acceleration in global crude market tightening over the past couple of months has played out most visibly in weekly US statistics, particularly for crude. The tightening has come as a result of four simultaneous forces at play: limited domestic production growth, the ramp-up in refining activity, a strong pull on crude exports in late spring and the slow recovery of imports.
- The combination of high exports and high runs (90+% capacity utilization) have been the main drivers of the nearly 50 MMbbl in crude stock draws over the past three months, yet some of the math is starting to reverse.
- WTI is now more expensive than (or at parity with) 2nd month DME futures for Mideast medium sour crude and ~$1.60 cheaper than its Atlantic Basin cousin light sweet ICE Brent, yet exports remain robust, with the latest weekly figure coming in over 4 MMb/d, still reflecting the wave of purchasing that unfolded months earlier. Tougher economics and recent OPEC+ measures to inject more volumes into global markets will help throttle back exports after mid-July as barrels that have been nominated earlier clear the ports, and spot buyers ease back.
Chart 4: US export barrel and Brent forward curve (inverse values)
Escape velocity: Understanding the UAE perspective that led to the OPEC+ disagreement and what it means
- The UAE’s gambit that led to the recent compromise agreement is the culmination of both tactical and strategic considerations, capitalizing on market conditions.
- From a tactical standpoint, the UAE perceives that it has shouldered a disproportionate share of the production cut burden since 2020 by virtue of the initial baseline maneuvering that saw Russia and Saudi Arabia synchronize baselines at higher levels. On a percentage of capacity basis, the UAE cuts are indeed well in excess of cuts made by other large OPEC+ members. Under OPEC+ output restrictions the UAE did not use 34% of its total capacity—a higher level of unused capacity than that of the other holder of major spare capacity—Saudi Arabia. Besides business reasons, Abu Dhabi would also like higher production rates to support the futures market for Murban, its largest grade of crude oil at 1.8 MMb/d. Murban futures contracts started trading in March 2021, and one of the factors in its success is a large volume of production.
- From a strategic standpoint, the UAE has long tried to thread the needle between contributions to short-term market stability and the restructuring of the country’s energy sector centered on monetization of resources via expansion rather than holding spare – and eventually stranded – capacity. In recent years, the UAE has substantially increased crude oil production capacity and it is now estimated at 4 MMb/d (or perhaps a bit higher) compared with 2016‒17 capacity estimated at about 3 MMb/d. After both key onshore and offshore oil fields were restructured in 2017 (the old concessions ended in 2014 so it was a lengthy process) in late 2018, the Supreme Petroleum Council approved a $132 billion investment plan, and Abu Dhabi National Oil Company (ADNOC) reemphasized expanding production capacity mainly in existing fields. After five years as the (mostly) loyal lieutenant as Saudi Arabia’s own market management strategies have swung dramatically, it now perceives that it has reached escape velocity to break out of the volume/price dilemma, capitalizing on more favorable market conditions and legitimate grievances.
Chart 5: Unused UAE crude production capacity, the share of total capacity
Delta fatigue: Deep lockdown risk fades, but regional divides grow
- Global oil demand recovery plays out according to plan, but variants and slow vaccination outside of developed markets mean hopes of a swift boom in “pent-up” demand above 2019 levels looks unlikely. We have lifted our 3Q2021 global crude oil demand outlook by 0.3 MMb/d to 99 MMb/d, now 6.6 MMb/d above 1Q2021levels. We have maintained our expectations for 2022 demand levels to average 101 MMb/d, in line with 2019 annual average levels, with 2H2022 to exceed 2H2019 levels by 0.9 MMb/d on average.
- In our base case outlook, refined fuels consumption blossoms 4.6 MMb/d between June and December. Light distillates account for 2.3MM b/d of this forecast and are on their way to meet expectations as regional mobility favors gasoline
- One quarter of this increase is in jet fuel and kerosene, concentrated in the US, Asia (ex. mainland China), Latin America and Europe. The delta variant increasingly puts this consumption at risk, as it slows down a full return of international travel.
Chart 6: Variants slow regional recoveries down