Crude Oil Market Headed Toward Rebalancing

A significant increase in the global oil supply had pushed oil prices downward in the final months of 2018. However, the outlook for 2019 looks more promising, although there is some amount of uncertainty. Trade disputes, a supply-demand imbalance in the U.S., and concerns over the general financial and economic health globally will be the major talking points for 2019.

What Happened in 2018?

The spot crude oil price averaged at $57/barrel in December 2018, witnessing a decline from an average of $81/barrel in October 2018, which has been the highest since October 2014. The U.S. sanctions on Iran and Venezuela had drastically reduced the supply of sour crude, which tends to yield larger volumes of distillates that are of higher value. This move had created quite a stir from a demand perspective, as oil refiners from the emerging economies started looking out for other options, resulting in a massive supply-demand imbalance. The market also experienced record levels of crude oil production from the U.S., Saudi Arabia and Russia, owing to which an over-supply was witnessed, resulting in a decline in prices.

Major Factors Driving the Fall in Prices

The drop was majorly due to a significant increase in oil inventories. To tackle the rising supply of oil, OPEC countries announced a reduction in production from January 2019. However, a continued decline in prices indicates that a production decline might not be enough to counterbalance the rising oil production levels in North America. The U.S. now ships oil to South America and Europe. For economies such as South America and Europe, the sanctions on Iran and Venezuela have led to the U.S. becoming the next best option for importing oil.

Moreover, the global oil demand has been moderately stable in comparison to the supply, resulting in rising oil inventory levels. Increasing oil production in the U.S. and other non-OPEC countries is contributing to a growing global oil inventory that is expected to reach 0.2 million barrels/day in 2019 and 0.4 million barrels/day by 2020. However, some of the oil inventories produced by Iran would not be available to the market, at least temporarily, owing to the U.S. sanctions.

Market Expectations in 2019

In 2018, the crude oil demand remained stable at 1.3 million barrels/day, while in 2019 it is expected to increase up to 1.4 million barrels/day. The demand from European and some Asian economies is likely to be relatively weak owing to the economic slowdown and trade conflicts.

In China, the crude oil demand in 2019 is likely to increase only by 0.34 mbpd due to the escalation of trade tensions between the U.S. and China. India will continue to depend on imports for its oil needs in the short term; however, the government is taking measures to reduce its dependence on imports by implementing several policies.

Factors to Watch Out For

• China’s economic health: One of the world’s largest oil consumers is expected to witness an economic slowdown in 2019. Moreover, the decrease in the Chinese producer index and consumer price inflation may hit the global and Chinese economy to a large extent.
• Global recession and financial turmoil: 2018 witnessed multiple sell-offs in the U.S. stock market due to fears of a financial crisis, slow growth and the trade war. In 2019, the health of the global economy will be monitored closely due to the U.S. yield curve inversion.
• Iran waivers: Sanctions on Iran and the waivers from the U.S. are expected to be among the major factors driving the markets in 2019. The renewal of waivers that have already been granted to major buyers of Iranian crude oil is far from a certainty. Any decision to renew or repeal them will heavily impact oil prices.

Conclusion

Brent crude oil is expected to remain on the lower side as compared to 2018, averaging in the range of $61-64/barrel in 2019 and $65-69/barrel in 2020. However, the market may witness a surge in prices during the last quarter of 2019 and the early quarter of 2020 due to an increase in demand for light-sweet crude oil from refineries owing to IMO regulations.

WTI crude oil prices are expected to be in the range of $4-6/barrel, lower than Brent prices in 2019 and $4/barrel lower than Brent prices in 2020. These forecasts are based on the assumptions that crude oil production in the Permian Basin, and current constraints on the capacity to transport crude oil to West Texas and from Cushing, Oklahoma to refineries and export terminals along the U.S. Gulf coast, will continue until mid-2019.