Busting some myths – why we differ on the oil and gas outlook

ING’s oil and gas analyst Hamza Khan looks at the current state of supply and demand for crude oil and natural gas, and explains why he and his team come up with some rather different forecasts from the oil and gas market consensus.

 

Oil prices have halved since the summer of 2014 due to the new US shale supply and gas prices in Europe and the US remain below seasonal norms. This has led market analysts to speculate that prices will continue to fall. However, there are a number of supply and demand factors that suggest this will not be the case. We also question whether production is as efficient as it appears and dispel some widely held assumptions about market trends, which lead us to a very different forecast from current consensus.  

 

On the supply-side, we are seeing geopolitical constraints: 

  • Production in Nigeria has been maximised ahead of a contentious election and is likely to slow after the results have been decided in late March.
  • Protest movements in Algeria against shale gas production have led to the recent scrapping of drilling plans.
  • Instability in Iraq and Libya were the leading cause for the three year high of OPEC unplanned outages (where production targets are missed), which measured 2.7 million barrels per day in December 2014.
  • Ongoing Greek and Iranian negotiations and instability in the Ukraine are all issues that will have an impact on future pricing.

 

Oil demand is higher than the consensus of market analysts suggests: 

  • We have not seen a demand induced sell-off – Chinese crude oil imports are now double 2009 levels.
  • Oil demand in China and India will increase by 16 million barrels per day over the next ten years.
  • Changes in global supply can often lead to an overreaction in price fluctuations – the large deficit in 2007 led to a $30 rise per barrel, which quickly reversed in 2008. Therefore it is likely the $53.5 fall in 2014 due to a slight surplus will also be an overreaction that is soon reversed.

 

There are also some myths of importance that we need to recognise, namely around the perceived production efficiency in oil and gas and current market trends.

 

Oil production is not as efficient as consensus estimates: 

  • While efficiency has improved with production for natural gas, this is not the case for oil. More rigs are required for more oil and while production per rig has halved since 2010, employment rose by over a third.
  • Equally, shale oil rigs do 65% of production in their first year, followed by a rapid decline.
  • Recent US rig fall has been dramatic, from a peak of 1,600 in September/October, to just 1,223 today.

 

The rising trend of fuel efficient cars in the US is a myth: 

  • SUVs have increased their sales lead over compact cars since 2009, with more fuel efficient vehicles selling only a tenth of SUV numbers.
  • US motor gasoline demand has now returned to peak 2007 levels, despite urbanisation and efficiency trends.

 

However, there remain some bearish factors to keep in mind: 

  • OPEC refuses to cut production, because it is no guarantee of a higher price. They would simply sell fewer barrels at a lower price, which is a double loss.
  • Markets have recently been more optimistic about certain geopolitical risks – the deal between the Kurdish regional government and the central Iraqi government is flagged as a positive for production.

 

Yet, having exploded some myths, the bottom line is that we believe the bottom in oil prices has been reached. The question now is not so much whether prices increase, but how quickly and how far.