Brent crude was trading above $90 a barrel in April, but towards the end of September it was hovering around $70 and is now back close to $77. Why such nervousness in commodity markets? What are the key factors?
The first aspect to note is that there is a disconnect between the physical and futures markets. The physical market is in deficit, supported by northern hemisphere summer travel demand, supply restrictions from Opec and sporadic supply disruptions such as those seen in Libya, resulting in inventory drawdowns over the past few months and levels below their five-year ranges.
Despite these supportive fundamentals, markets turned bearish on oil towards the end of September and net positioning was at record lows as markets showed their concerns about the substantial supply expected to come online in 2025.
The supply side has been a driver of the market as non-Opec supply is set to grow by 1.5-million barrels per day (bpd) next year, driven largely by the ramp-up of long-dated, low-cost projects in Guyana, Brazil and Canada, and the growth in US shale supply. This new capacity should satisfy global demand growth even under the most optimistic global growth scenarios for 2025.
In addition, Opec has announced its intention to increase production by about 2-million bpd over 12 months, commencing in December, even as the market signals that this supply is not needed. This has led the consensus view to expect a surplus of about 1-million bpd in 2025, which is clearly bearish for prices.
On the demand side, we have seen robust growth over the past few years, supported by the post-pandemic normalisation in travel. However, demand growth expectations for 2024 and 2025 are more in line with long-term trend levels, barring a major recession. Most of this growth is expected from emerging economies in Asia, particularly China, as interest rates come down, the dollar weakens and economic growth improves.
China accounts for a large percentage of global oil demand, but growth is slowing in this market, as illustrated by the weakness in other commodity markets such as copper and iron ore. The transition to electric vehicles has also affected oil demand in China, with new electric vehicle sales reaching 45% of the total market in August. These factors have led to market concerns that peak oil demand from the world’s second-largest oil consumer — and one of the biggest drivers of oil demand growth over the past decade — has passed.
There are two main oil price drivers over the long term. In the past decade US shale has provided 80% of the new barrels that have come to market. However, as Wall Street imposes discipline on shale exploration, development and production companies, and because some are running out of high-quality inventory, shale growth is slowing. This year, shale production is expected to grow at about 300,000 bpd and 400,000 bpd, likely slowing to between 100,000 bpd and 200,000 bpd of year-on-year growth next year, with shale production peaking around 2027.
The shale slowdown is a market driver for oil as there is little point in Opec managing the market to keep oil prices high if shale production sucks up the growth and Opec loses share. The structural slowing in shale encourages Opec to manage the market and if the cartel is patient it can be optimistic on a three to five year view.
As the global population continues to grow, emerging economies will consume more oil. Of the planet’s 8-billion people, about 1-billion consume about 13-billion barrels of oil per year, while the other 7- billion consume just 3-billion. In the past few months we have seen some commentators prolong estimates for peak demand as electric vehicle adoption lags. So in terms of peak oil demand, our best guess would be the early 2030s.
As the US enters another election cycle, speculation is growing around increased fossil fuel extraction in the US should Donald Trump regain the presidency. However, despite President Joe Biden’s commitment of “no new drilling, period” in the run-up to the last election, US oil production grew significantly under the Democrats.
A Trump win may be felt most in natural gas pipelines and infrastructure, as it is now difficult to build pipelines across US state lines due to central government approvals. While his influence may be most pronounced in natural gas, we are unlikely to see a surge in US oil production if there is a Trump win.
And, despite his mantra of “drill, baby drill”, the discipline imposed on the shale exploration, development and production sector means a Trump win is unlikely to have a negative effect on oil prices. If anything, it may be positive for oil prices as he may adopt a more draconian view of sanctions on Iran, with the potential to gradually eliminate 1-million bpd from the market if sanctions are implemented.
Another emerging theme in markets is the possibility of a global economic slowdown in 2025. Given oil prices’ strong influence on inflation and interest rates, and their meaningful impact on global growth, the weakness in prices we have seen this year may be driven by expectations of softer growth. As the world emerges from a period of high interest rates, oil prices have remained stubbornly high due to Opec intervention. In 2025 we expect oil prices to react to the unwinding of these interventions and the resulting supply growth, rather than an economic slowdown.
As Chinese demand tails off concerns over the future of oil, prices will grow. However, there is a natural balancing mechanism: lower prices lead to higher global demand as sectors such as manufacturing and logistics become more competitive, which should be supportive for oil demand growth.
• Gooden is a portfolio manager, Docrat an analyst, at Ninety One.
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