Oil prices plunged last week, dragged down by fears of slowing demand, and shrinking geopolitical risk premia.
An unexpected increase in inventories underscored the downside risk to oil prices. The EIA reported a drawdown in crude stocks, but a huge 9.25 million barrel combined increase in gasoline and diesel inventories, which surprised traders. Also, gasoline demand plunged by 0.5 mb/d in the week ending on July 12, although week-to-week changes are typical and make the data a bit noisy.
Crude prices sold off on the news, falling by nearly 3 percent on Thursday.
The data release renewed fears of a slowdown in demand. But cracks in U.S. demand are larger than one week’s worth of data. “The [year-on-year] increase in demand for the year to 11 July was just 29 thousand barrels per day (kb/d), up 0.1%,” Standard Chartered wrote in a note.
“Demand will have to be strong for the rest of the year if consensus forecasts for 2019 growth are to be achieved.”
The investment bank sees U.S. oil demand only rising by 89,000 bpd this year, while the EIA expects a stronger 248,000-bpd increase. Standard Chartered says U.S. oil demand “appears consistent with a slowing economy.”
The worrying thing for the oil market is that the U.S. economy has held up better than elsewhere.
In China, GDP growth has slowed to its weakest pace in nearly three decades. India, which is widely seen as the most important source of oil demand growth in the medium- and long-term, has also disappointed.
The International Energy Agency (IEA) said that global oil demand only grew by 0.45 mb/d in the second quarter. That contributed to a surprise 0.5 mb/d supply/demand surplus in the second quarter. As recently as June the IEA anticipated the oil market would see a 0.5 mb/d deficit.
The agency said that there were many reasons for tepid demand in recent months.
“European demand is sluggish; growth in India vanished in April and May due to a slowdown in LPG deliveries and weakness in the aviation sector; and in the US demand for both gasoline and diesel in the first half of 2019 is lower year-on-year,” the IEA wrote in its July Oil Market Report.
Nevertheless, the IEA stuck with its full-year forecast for demand growth at 1.2 mb/d, arguing that economic growth would rebound in the second half of 2019. Some of that optimism hinges on a resolution to the U.S.-China trade war, which seems a bit speculative. Reports suggest that trade negotiations are “stalled” while the Trump administration wrestles with how to handle Chinese tech giant Huawei. The Trump-Xi meeting on the sidelines of the G20 conference in June was supposed to lead to a restart in trade talks, but as the Wall Street Journal reports, no meetings have been scheduled as of yet. The WSJ also said that the Trump administration “appears to have resigned itself to a drawn-out battle.”
That certainly calls into question the optimism surrounding the IEA’s demand growth figures. “Both IEA and EIA remain optimistic in assuming an economic rebound in 2H19 and see global demand growth nearly tripling from ~0.6 mb/d y/y in 1H19 to ~1.5-1.8 mb/d y/y in 2H19,” said Allyson Cutright, Senior Analyst at Rapidan Energy Group. “While we do see some pickup in 2H19, in particular in China due to macroeconomic stimulus and eased restrictions on gasoline-cars, the overall trend in agency revisions is still probably headed down.”
Weak demand and rising supply are creating a perfect storm heading into 2020. The IEA said that the “call on OPEC” could fall by 0.8 mb/d next year, and even that is based on the agency’s rather optimistic demand growth figures.
As a result, OPEC+ has a serious problem on its hands. On the one hand, it can continue to cut production in order to prevent oil prices from collapsing. But that would require mustering up consensus and taking on deeper sacrifice. The alternative is not much better. OPEC+ can keep the current production cuts in place (or abandon them altogether) and let prices crash.
“Our balances have long assumed OPEC+ would have to extend and deepen cuts next year and project Saudi Arabia will be the brunt of the additional cuts,” Allyson Cutright of Rapidan Energy Group said.
“Our most recent update sees Saudi Arabia need to cut production toward the low-9 mb/d range next year, and that’s assuming decent economic growth.”
Rapidan is betting that OPEC+ will opt for cutting, which might be just enough to head off a price slide. “However, if a recession develops or US sanctions on Iran are removed, then the deluge of new oil would more likely prove too large for OPEC+ to manage and oil prices would bust,” Cutright said.
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