The key takeaway from OPEC’s updated long-term demand forecasts released yesterday is that peak oil has yet to arrive. In what was thinly veiled rebuke at last month’s BP report suggesting the opposite may be true, the organisation said global oil demand will surpass the pre-COVID level in 2022. What is more, it insisted that consumption will continue to grow over the next two decades, albeit at a slower rate than expected due to the lingering effects of the coronavirus pandemic. OPEC now reckons demand will grow from 90.7 mbpd this year to 109.3 mbpd in 2040, a downward revision of 1.3 mbpd from last year’s report. It added that demand will fall to 109.1 mbpd in 2045, the first clear cut admission of when oil consumption will eventually decline.
Returning to the here and now, Brent and WTI were spurred higher on Thursday by a spate of involuntary supply outages. Hurricane Delta has shut more than 90% of US production in the Gulf of Mexico, effectively halting around 1.5 mbpd of output. Meanwhile, a strike by Norwegian oil workers has cut the country’s output by around 330,000 boepd. Norway’s oil and gas association has warned that supply could be slashed by up to 966,000 boepd unless the conflict is resolved by October 14. Oil companies and labour unions agreed to mediation in bid to end strike and are due to meet with a state-appointed mediator today. It goes without saying that a resolution to the conflict would pull the rug from under bulls’ feet.
All the while, shares on Wall Street inched higher amid a wave of stimulus optimism. Donald Trump suggested relief could soon be reached, just days after abruptly ended negotiations on a major COVID aid package. The need for fresh stimulus measures was highlighted yesterday by a sombre health check of the US labour market. Another 840,000 Americans filed claims for unemployment benefits last week. First time claims appear to have levelled off at a worryingly high level having averaged 867,000 over the past six weeks. This is not the V-shaped recovery that many had forecast. If lawmakers didn’t sense the urgency to cobble together some kind of piecemeal stimulus, they will now.
Playing catch up
This week’s supply disruptions on either side of the Atlantic have supported the US and European crude benchmarks in equal measures. Consequently, the recent narrowing of the WTI/Brent spread has been unwavering. WTI’s discount to Brent came within 57 cts at the end of last month, the smallest in four months. The arb has since stabilised above -$2/bbl having traded as low as -$11/bbl in April.
The shrinking spread reflects a multitude of supportive developments across the US crude patch, chief among which are tightening localised fundamentals. US oil production fell by around 2 mbpd earlier in the year as producers responded to the COVID-induced demand shock and price crash. Alongside this positive supply-side backdrop, WTI has benefited from increased pipeline capacity and strong foreign appetite for US crude. The amount of black gold leaving the US border has averaged around 3 mbpd over the past three months. This combination of plunging domestic oil production and heightened crude exports has paved the way for a drawdown in stockpiles. Crude inventories declined in all but three of the last 14 weeks by a cumulative 47 million bbls.
More recently, US production has risen from its lows. That said, the estimated September production level of 11.2 mbpd is still 1 mbpd below the 2019 annual average, according to EIA estimates. In contrast, total production in Norway and UK — much of which is delivered or priced against Brent crude oil — was slightly higher than the 2019 annual average in September of 2020, says the EIA. These differing production profiles have continued to support US crude grades.
Another reason why the US crude marker is finding support relative to its European counterpart is the weaker-than-expected fuel demand recovery. Sluggish Asian demand for WAF crude and renewed lockdowns in Europe are having an outsized impact on the Brent benchmark given its international standing. All the while, the recent uptick in OPEC+ production is also putting downward price pressure on Brent relative to WTI. This flurry of fresh supply from producer alliance has been further compounded by the unexpected return of Libyan oil barrels.
Looking ahead, the shrinking path of the WTI/Brent spread is poised to continue as US production declines anew. Most curtailed production has already been brought back online in response to rising prices, and the EIA expects crude oil production to drop to 11 mbpd in 2Q21. This is on the assumption that new drilling activity will not generate enough production to offset declines from existing wells. While markets adjust to the lower-for-longer outlook for US crude production, the supply of Brent-linked crude is set to swell in the new year. OPEC+ is due to relax supply curbs in January by a further 2 mbpd.
Needless to say, this wave of additional supply will likely keep the Brent premium under pressure. Underscoring this sentiment are EIA forecasts that the WTI-Brent spread will average -$1.50/bbl in the current quarter and around -$2/bbl in the first half of next year. In other words, the price gap between the two crude benchmarks will remain narrow in the coming months. Yet not everyone will be cheering WTI’s bout of strength. The waning discount relative to its global peers risks undermining robust US crude export levels as WTI-linked cargoes become comparatively less attractive.