Discerning market pessimism from fundamental-based movements can be difficult, especially with all the moving oil has done in the last year plus. And to be sure, both have played significant roles to date. Still, any way you slice it, the current downturn is fundamentally sound, i.e., reinforced by inventories, seasonality, and the supply and demand balance. Thus, the question is really two-fold. Firstly, how long and to what extent will the glut persist? And, secondly, to what degree will China influence matters?
Let’s begin with the excess oil. Recent data puts the supply and demand differential at an average of 1.94 million barrels per day (mbpd) for 2015, or more than double what it was in 2014. Crude oil and liquid fuels production was up across the board – 4 percent in North America, 4 percent in Latin America, 1 percent for Russia and the Caspian Region, 2 percent in the North Sea, and 3 percent among OPEC countries. Most notably, Iraqi, Saudi, and US crude production grew 20, 3, and 10 percent respectively, adding roughly 1.8 mbpd combined through the first 9 months of 2015.
On the whole, production growth this year will not be as robust as in 2015, especially relative to consumption growth. Notable decline will take hold in several areas. In the United States, crude oil drilling productivity on the seven most prolific plays fell by some 300,000 barrels per day (bpd) in Q4 2015 and is projected to drop another 100,000 bpd by the end of February. Looking further ahead, US crude production is expected to average 8.7 mbpd in 2016, down 700,000 bpd from 2015. Russian output will also slip, though more slowly, from its record levels, and the North Sea will slink back into decay.
Still, OPEC looks to continue its onslaught, however disjointed. Saudi Arabia has no intention of cutting its vigorous production and Iran could flood the market with up to 750,000 additional bpd by the end of 2016 as international sanctions are stepped down. As such, global markets will remain oversupplied for most of the year, with demand not significantly rising until Q3. With consideration given to all the moving parts – at least to the extent possible – the global glut will likely sit fluidly between 0.8-1.5 mbpd through 2016.
Now, the above assumes Chinese demand remains steady, which is to say growing; though the extent of said growth is a topic of uncertainty. The IEA, for one, expects Chinese demand growth to sink to 350,000 bpd in 2016, a projection borne out the country’s broader economic headwinds, which have fueled oil bears. Still, Chinese crude demand was up 4.8 percent in 2015 and crude imports surged nearly 9 percent as the country looked to fill government and commercial reserves with cheap oil. Overall economic growth looks to slow further to 6.3 percent in 2016 and 6 percent in 2017, but the consumptive indicators remain relatively positive.
Chinese vehicle sales well exceeded expectations in 2015 and the strong upward pressure on gasoline is expected to continue through 2016. More broadly, China’s consumer economy is projected to expand nearly $600 billion in 2016; the number of upper-middle-class households and the rate at which those households spend are both rapidly rising. Industrial output should match, if not exceed the pace in 2015.
For its part, China sees it’s crude demand rising to 11.32 mbpd in 2016, up approximately 460,000 bpd from last year. Net crude imports are slated to swell 7.3 percent to 7.14 mbpd – Saudi Arabia being the primary beneficiary. Further, China seeks to dramatically expand its strategic petroleum reserves (SPR) by 2020. Some 360 million barrels of capacity still wait, and 2016 could see China import 150 million barrels of SPR-destined crude.
While reduced, China’s moderate-to-strong demand – both current and projected – is hardly the singular force behind oil’s dramatic slump. In fact, it’s one of the few positives, keeping the floor from utterly collapsing. China won’t absorb the glut alone, but it doesn’t have to; deferred capital expenditures and/or a minor geopolitical shock should take care of that before too long.
First published at Oilprice.com