Pouring oil on troubled waters

The breakdown in OPEC negotiations has prompted a nose-dive in the oil price benchmarks around the world as expectations rise of a production glut due to OPEC members chasing market share. The key US benchmark, West Texas Intermediate closed on 9 March at US$33.18/barrel, while the European equivalent, Brent dipped to US$35.09. in both cases this was a fall of US$10 in a single day. With the softening Australian dollar, these prices equate to around A$50/barrel.

The vampire squids at Goldman Sachs are now forecasting prices to average around US$30 through much of the rest of the year, with possible lows approaching US$20. This sustained low price has not been seen since the 1990s (with adjustment for inflation).

Oil is not used in any significant quantities for electricity generation in the NEM, so the main impact will be through the knock-on impact on the cost of gas. East Asian contract gas prices are pegged to the main Japanese oil price benchmark and domestic prices tend to rise and fall with the export price. Spot prices for LNG had already dropped significantly following the coronavirus outbreak, but this doesn’t necessarily follow through to new contracts, which set prices for a longer period. On the demand side, while oil and gas producers will likely be reducing demand, lower energy costs could help boost manufacturing, with the caveat that this boost may be dependent on getting through the economic dislocation of the virus and efforts to contain it.

Longer term, the most recent IEA outlook for oil is for modest growth on both the supply and demand side. However, this is based on an assumption that oil prices rebound to around US$60/barrel (A$90). The IEA notes that the US, which is expected to deliver almost half the net new supply to 2025, is more sensitive than most to oil price fluctuations, as its new supply is largely shale oil where production can be ramped up and down depending on the price.

Chart 1: Oil forecast supply and demand changes 2020-25, mbl/day

Source: IEA

On the demand side, the IEA sees demand for motor fuel remaining almost flat. Even so, the IEA has long been criticised – largely by environmentalists – for its conservative approach to technology shifts and their impacts on fossil fuel demand. They argue that its forecasts for coal demand have consistently underestimated the inroads that renewables have made. If the IEA is too cautious in its assumptions about the uptake of alternative fuel vehicles then demand could fall over the next five years, especially if combined with longer term global economic repercussions from the coronavirus. While it’s too soon to be calling peak oil, we could be in for a sustained period of low oil and gas prices.