“The oil market looks to be broadly balanced in 2019, an improvement on 2018 which turned out oversupplied,” Morgan Stanley analysts Martijn Rats and Amy Sergeant wrote in a note. “This supports a partial oil price recovery.”
The investment bank says that the plunge in oil prices has “overshot,” with the selloff having been magnified in December due to the global financial turmoil.
To be sure, the fundamentals did turn negative, with weaker expectations for demand, weaker time spreads in the futures market, and higher inventories. In the short run, the ramp up of OPEC+ supply before the December decision to slash output will take time to filter through the market.
Morgan Stanley argues that a similar thing happened the first time around when OPEC+ agreed to cut production at the start of 2017. Producers ramped up output in the weeks and months ahead of the deal, and that new oil set sail just ahead of the implementation of cuts.
As a result, in the first half of 2017, inventories barely budged, even as production fell. It took several months before all of those additional barrels arrived at their destination and became integrated into storage facilities, and ultimately worked off by the market. It wasn’t until the second half of 2017 that visible inventory data began to demonstrate significant declines. Morgan Stanley says a similar thing might happen this year, which could cap oil prices at $65 per barrel.
Floating storage has already begun to creep up, and the corresponding deterioration of timespreads has also occurred. The Brent forward curve has moved more sharply into contango recently, a situation in which near-term prices trade at a discount to longer-dated futures. Both floating storage and the contango are symptoms of a marker that is well- or over-supplied. The OPEC+ cuts are phasing in, but will take time to have an impact. Morgan Stanley slashed its oil price forecast by $8 per barrel, expecting Brent to average $61 this year, down from a previous estimate of $69. But the investment bank does see a “partial rebound” of Brent oil prices into the mid-$60s. The bank says that the oil market was oversupplied by about 0.6 mb/d in 2018, but things look better this year.
“With demand growth in 2019 of ~1.2 mb/d and year-on-year decline in OPEC supply of 1.1 mb/d, offset by non-OPEC growth of ~1.6 mb/d, we expect supply and demand to be broadly in equilibrium over the year, an improvement over 2018,” Morgan Stanley concluded.
Of course, the situation is dynamic. The decision of OPEC+ to slash output will help boost prices, but that also makes it less likely that US shale growth will slow. In 2020, shale output is expected to grow by even more, after the inauguration of new pipelines unlock new supply later this year. Wood Mackenzie and Rystad Energy both see non-OPEC output growth of between 2 and 3 mb/d in 2020, which will exceed total global demand growth. That suggests that the OPEC+ cuts might need to remain in effect beyond this year, although that also means the cartel cedes even more market share. It’s a riddle that Saudi Arabia and its partners will be hard pressed to figure out.
One consequence of U.S. shale continuing to grow while OPEC+ countries keep barrels off of the market is the increasing shift towards lighter oils in the global crude slate. Oil from West Texas tends to be light, while barrels from Saudi Arabia are more of the medium variety. Prices for gasoline and naphtha have grown increasingly weak – a result of the surging supply of light oil. Meanwhile, medium and heavy supplies are less abundant, and diesel prices reflect that.
This light/heavy disparity could grow as the year wears on, with the impending regulations on marine fuels from the International Maritime Organization (IMO) set to take effect at the start of 2020. The IMO rules will force dirty fuel oil out of the mix for ship-owners, and diesel and other distillates will be called upon to fill the void. Analysts have long predicted that the IMO rules could drive up global crude oil prices.
For now, WTI is trading just above $51 per barrel and Brent at $61. Analysts are not suggesting a return of last year’s price levels, but the consensus seems to be that the late-December plunge went too far. “We think the rally in oil prices has further to run in Q1,” Standard Chartered wrote in a note on January 10.