The Fuse

Weak Oil Demand And Supply Surge Could Create Renewed Surplus

by Nick Cunningham | July 17, 2019

Global crude oil demand has slowed to its weakest rate in years, dragging down oil prices. The top forecasters for the oil market have repeatedly downgraded their estimates for demand as the economy continues to slow. At the same time, supply growth is expected to continue apace, setting up a worsening glut in 2020, trapping OPEC+ in familiar conundrum of how to balance the oil market.

Absent a turnaround in global growth, the pitfalls for the oil market may only grow worse.

The three most widely cited oil forecasters – the U.S. EIA, the IEA and OPEC – have all downgraded their predictions for oil demand for 2019.

Demand weakens
The three most widely cited oil forecasters – the U.S. EIA, the IEA and OPEC – have all downgraded their predictions for oil demand for 2019. The EIA said in its latest Short-Term Energy Outlook that demand would slow to just 1.1 million barrels per day (Mb/d) this year, the sixth consecutive month in which the agency was forced to downgrade its forecast. Weaker economic growth was to blame.

A few days later, the Paris-based IEA issued its monthly report, where it also highlighted the unimpressive demand-side figures. In fact, the agency said that the oil market suffered a rather shocking 0.9-Mb/d surplus in the first six months of 2019. The IEA noted that it was way off on the second quarter, a period of time when the market was in surplus to the tune of 0.5 Mb/d. Just a month earlier, the IEA thought the market was in a deficit of the same size.

The IEA noted that “there are indications of deteriorating trade and manufacturing activity,” including the first global contraction in manufacturing activity since 2012. However, the agency curiously left its demand growth estimate of 1.2 Mb/d unchanged, and noted that “the mood surrounding the US/China trade dispute appears to have improved and the resolution of outstanding issues would be a massive boost to economic confidence.”

The problem is that while the Trump-Xi summit froze the current dynamic in place and may lead to a restart of trade negotiations, the tariffs remain. Indeed, the U.S. only recently hiked tariffs on $200 billion worth of Chinese imports from 10 to 25 percent, and the agreement on the sidelines of the G20 summit in late June did not reverse that increase. Moreover, not everyone is as sanguine as the IEA about the trajectory of the trade talks. “Businesses remain skeptical that the two countries will reach a broader trade agreement and recognize that trade tensions may escalate again.” said Tom Rafferty, a China expert at the Economist Intelligence Unit, according to the Washington Post.

There is ample data to suggest that the global economy is taking a hit and continues to slow. China just released data that showed that its GDP only expanded at a rate of 6.2 percent in the second quarter, the weakest rate in 27 years. Even that estimate could be overstated. “Economic conditions are still severe both at home and abroad, the global economic growth is slowing down, the external instabilities and uncertainties are increasing, the unbalanced and inadequate development at home is still acute, and the economy is under new downward pressure,” Mao Shengyong, a spokesman for China’s National Bureau of Statistics, said in a news conference.

China’s auto sales were down 10 percent in June compared to a year earlier, the 12th consecutive month of declining sales. “One of the major axioms of the global automobile industry, that China will continue to be a growth engine of world auto sales, is no longer the case,” Daniel Yergin, vice chairman, IHS Markit said in a statement. Notably, however, electric vehicle sales in China continue to rise. Between July 2018 and March 2019, EV sales in China grew at a monthly average of 85 percent compared to the same period a year earlier. While growing from a small base, EV sales are rising in a contracting market, resulting in significant gains in market share.

Meanwhile, economic concerns are not isolated to China. Global freight volumes are down, manufacturing and construction activity has been weakening and car sales globally have plunged. As a result of the broad slowdown, prices not just for crude oil but for a wide range of commodities – including soybeans, copper and LNG – have all declined.

Oil market could suffer surplus
Seasonally, crude oil demand tends to pick up in the second half of the year, and current demand forecasts all hinge on a rebound in consumption. But the IEA says demand growth will soar to 1.8 Mb/d in the second half of 2019, even as it points a variety of downside risks. To be sure, the IEA’s assessment is based on more than just seasonal quirks. The International Monetary Fund, for instance, is optimistic as well. “While 2019 started out on a weak footing, a pickup is expected in the second half of the year,” the IMF said in its World Economic Outlook released in April.

But because the IEA’s full-year forecast for oil demand growth – 1.2 Mb/d – hinges on that rebound, if the second half of 2019 does not see the expected surge in demand, more downward revisions could be possible.

Weakening demand is ill-timed given the expected ongoing increases in U.S. oil supply.

Weakening demand is ill-timed given the expected ongoing increases in U.S. oil supply. Only recently, OPEC+ announced a nine-month extension of the production cuts, acknowledging that market intervention would be required longer than previously thought.

However, the latest data from the top forecasters suggests that the cartel’s task only grows trickier next year. The IEA said that “market tightness is not an issue for the time being and any re-balancing seems to have moved further into the future.” While the IEA only sees demand growing by 1.2 Mb/d this year and 1.4 Mb/d next year – which, as previously mentioned, might prove to be overly optimistic – the market could get swamped by supply increases.

Even if the IEA is correct, and the more optimistic demand scenario plays out, non-OPEC supply (largely the result of U.S. shale) is still expected to grow by 2 Mb/d this year and by 2.1 Mb/d next year. In other words, while OPEC+ cuts will largely offset supply growth this year, the surplus is set to return in 2020.