Like many of you, we’re happy to close the books on 2020. The COVID-19 pandemic put the entire industry to the test, and we were not immune to this year’s challenges. Is oil demand really recovering?
With vaccines rolling out across the globe and economies opening back up, there’s room for measured optimism in the macro picture for energy. Here are some of the key supply and demand trends we’re monitoring as we move into the new year.
Oil Demand Recovering as Economies Reopen
The economic fallout from COVID-19 pushed oil consumption down to 93.2 million bpd last year or 8.7 million b/d below the 101.9 million bpd consumed in 2019. Despite the growing popularity of the “death of fossil fuels” narrative, it’s important to note that 2019 marked the tenth consecutive record high in global petroleum consumption. And all signs indicate that crude oil demand remains alive and well as economic activity returns to normal.
Analysts from S&P Global expect world oil demand will rebound by 6 million b/d next year. That’s just 2.6% below 2019’s record levels. Assuming a successful vaccination campaign and global economic recovery, many analysts expect new record highs in oil consumption within the 2022 – 2023 time frame. Asian economies will lead the rebound, where demand will grow by 1.7 million b/d next year to reclaim pre-COVID record highs. Roughly 70% of this growth will come from China and India – the two key countries driving the longer-term growth trend in hydrocarbon consumption.
U.S. and European oil demand recovery will lag behind Asia, mostly from the ongoing impairment in jet transport, representing 3.1 million b/d of the 8.7 million b/d in 2020’s lost demand. Analysts expect air travel to remain depressed through at least the first half of 2021 until widespread vaccinations give consumers the confidence to return to their pre-pandemic travel patterns.
Meanwhile, the supply side of the equation is supporting the market as anticipate oil demand recovering.
OPEC Shifts from Price War to Co-Operation
Last March, oil prices were coming under pressure from the escalating pandemic lockdowns when OPEC and Russia failed to support the markets with a supply cut. Some called it a “price war” at the time, but the war didn’t last long. After prices plunged deep into negative territory, the two sides came together with the rest of the OPEC members (OPEC+) to broker a 9.7 million bpd production cut starting in May. This record production cut helped draw down bloated global inventories, allowing prices to recover into the $40 – $50 range in recent months.
Some feared a renewed flare-up in tensions as negotiations reached a deadlock last weekend. The group was split on how or whether to continue releasing more supply onto the market as global oil demand recovers. Russia and Kazakhstan both wished to continue adding 500,000 bpd in new supply each month, while the rest of the group lobbied for continued restraint given the recent COVID flare-ups around the world.
But on Tuesday, Saudi Arabia facilitated a compromise by agreeing on a voluntary cut of one million bpd in February and March. This concession helped broker a larger deal that allowed Russia and Kazakhstan to boost their output by 75,000 bpd in February and March. Markets cheered the compromise, sending WTI Crude rallying above $50 on the news.
As things stand today, the combined OPEC+ production cut keeps 7.2 million bpd of production off the market. But most importantly, unlike last spring when prices crashed, the group appears fully committed to co-operation and supporting the market from here.
Finally, it’s not just OPEC+ keeping supply off the market – U.S. producers are doing their part too.
The Growing Possibility of Peak Shale
As long-time followers know, we’ve been writing the return of rational economics in U.S. energy markets for some time now. The process started gaining traction in 2019, as investors grew weary funding top-line production growth at the expense of bottom-line profitability. The pandemic only accelerated this movement. U.S. drillers have cut over 2 million bpd of crude and condensate production, from a peak of 13 million bpd in November of 2019 down to 10.9 bpd in December, per the latest EIA estimates.
Analysts at S&P Global expect U.S. output to shed another 1 million b/d through the first half of 2021. Most industry experts share a similar view, based on today’s depressed oil rig count – which leads production by roughly 6-months. Going forward, analysts are split on what happens next. S&P Global projects a return to U.S. production growth in the second half of this year. Others are less optimistic, including Raymond James analysts who project’ that U.S. oil supply has already peaked. This view is based on U.S. oil rigs remaining capped at 400, which would send U.S. production into secular decline, as detailed in the chart below:
US Oil Demand Recovery Outlook
As regular readers will recall, we’ve highlighted the key 500 level in the U.S. rig count required just to maintain production at current levels. So in a world where rigs top out at 400, this scenario could very well play out. As it stands today, U.S. oil rigs sit at just 267 – or roughly half of the level needed to grow production:
Given the widespread capital retreat from shale financing caused by over a decade of capital destruction, it’s very possible we’re entering a new era of “peak supply” from shale producers. Consider the recent commentary from Pioneer CEO Scott Sheffield, who claimed, “I never anticipate growing above 5% under any conditions… Even if oil went to $100 a barrel and the world was short of supply.”
Of course, we’ve heard similar things from shale CEOs before, so we’ll temper our optimism. But at the very least, we’ve likely seen peak shale growth, as the days of endless oversupply from reckless investment flows have clearly come to an end. This is not just an American phenomenon; we’re seeing substantial declines in energy investment across the globe, as captured in the following graphic.
Regardless of whether demand recovers in 2022 or 2023, this widespread underinvestment sets the stage for more attractive returns for those left behind financing the supply of the world’s most critical and widely consumed commodity.
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