G Chandrashekhar

Crude oil market may re-balance in mid-2015

G Chandrashekhar | Updated on January 24, 2018

Roadmap: One potential source of demand, albeit temporary, is creation of ‘strategic oil reserve’ - REUTERS   -  REUTERS

Consumption and production growth are slowing even as price remains low

While crude oil prices have collapsed — falling well below $60 a barrel — much to the chagrin of producers and delight of large consumers, the global oil market is in the process of ‘rebalancing’. Although oil is cheap, the market is unlikely to bottom out in a hurry; and in the process of rebalancing, one can expect mini-rallies from time to time. But such rallies will be short-lived and peter out soon.

Noticeable changes

The demand and supply fundamentals are currently undergoing noticeable changes. The market is witnessing slowing consumption demand and slowing production growth at the current low prices. Slowing global demand growth is a reality. Lower global GDP growth projections would translate to a decline in crude demand growth in 2015. Some experts estimate the fall at 10 per cent over the year. Europe is not doing well, while Japan is widely seen as moving towards recession. But this picture is tempered by the possibility of upside demand surprises, especially from the global power sector which can deliver demand growth. Lower crude price translates to lower petroleum price that encourages power generation.

Key driver

Again, large but price-sensitive countries like India and Indonesia can consume more oil at lower prices. There will be other price-elastic demand growth from other sectors.

The key driver of the market in recent months has been the US crude production. However, after the fall in price, the viability of some projects has become suspect. If the current price levels continue, the number of rigs in the US is widely expected to fall during the year. Significant production growth slowdown may be expected during the year, but much of it is likely to happen in the second half of the year, according to industry experts.

However, it is also reported that despite current low prices many producers are averse to cutting production in a hurry as it may risk reservoir damage. So, production may continue until cash costs stay above market prices over an extended period of time and test producers’ resolve.

Elsewhere, the OPEC has not yet decided on production cuts; but the cartel’s intervention can happen anytime. Reduced supply from the OPEC for whatever reason can potentially accelerate the rebalancing act. For the present, output in Libya is reported to be slowing.

Strategic oil reserve

Interestingly, around the world, producers are enforcing capital spending cuts to allow market to rebalance. However, there will be lag between such efforts and impact on market prices. The effect of the present capital spend pullback is likely to show results only a year later.

One potential source of demand, albeit temporary, is creation of ‘strategic oil reserve’. Low oil prices are sure to encourage countries to create such reserves.

It can be a large source of oil demand but temporary in nature. China is already engaged in building reserves. India may follow suit or logically should.

Given the slowing demand growth and slowing production growth coupled with absence of discretionary production cut by OPEC, supply demand fundamentals will slowly bottom out hopefully sometime in mid-2015.

For large importing countries the risk is what if, in the process of market rebalancing over the coming months, the world faces geopolitical events that can potentially disrupt supplies.

Geopolitical events

In the event, speculative capital is sure to return to the crude market, accelerating the price action. It is unclear if India, a major importer of crude with import dependence of 80 per cent, has put in place any risk management plans. It would be foolhardy to take the current low prices for granted.

Published on January 07, 2015

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