Following the Coronavirus-induced collapse in oil prices – during which the price briefly went negative – the market has recovered. With the price now stable at around $60/bbl, Market Voice analyses if this is a pause for breath or a natural ceiling.
- Following the decline in oil prices provoked by the COVID-19 pandemic, trading conditions have normalised and the price has risen in line with the economic recovery.
- The oil price is currently stable at $60, and a number of factors will determine the future direction, including tightening – or not – of demand conditions, fracking in the U.S. and the muddied policies of Saudi Arabia.
- The rise in popularity and production of electric cars will have a detrimental impact on the long-term prospects for potential increases in the oil price.
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Excess supply was plaguing the oil market over the last few years making storage space scarce at the onset of the COVID-19 pandemic.
The subsequent collapse in global demand wreaked havoc in the energy market as the surge in excess supply had nowhere to go, so settlement of the April 2020 futures contract saw crude price go negative to a brief low of -$40/bbl. to clear the market. But trading conditions quickly normalised with prices back to positive as soon as the April contract settled.
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Oil prices recover in line with global economy
Prices since then have gradually risen as the global economy gradually recovered.
Figure 1 shows the performance of crude oil prices since the beginning of last year but, instead of the rolling front contract, we show the next contract out to eliminate the extreme of the April contract settlement.
At that time, the next month contract – e.g., May settlement – dropped sharply but never went negative. This less distorted indicator of oil prices has tracked the U.S. stock market (the S&P 500 index). But as stocks continued to make new highs in March the crude oil price peaked at $65 and then stabilised at just below $60. Is this a temporary lull or is $60 a ceiling for oil prices?
Figure 1: SPX and crude oil (NYMEX) Prices
As shown in Figure 2, crude oil prices track the global net demand balance, as reported in the International Energy Agency, with tighter supply associated with higher prices.
Except for the turmoil in spring 2020, the direction and magnitude of quarterly price movements have been consistent with the demand versus supply dynamic.
The good news for crude is the recovery to the current $60 level is supported by the steady tightening in demand conditions over the past year, but the bad news is the International Energy Agency projects that even with the global economy rebounding from the pandemic over the next few years, there is no of significant tightening in demand conditions expected through the end of next year.
Figure 2: Quarterly net global demand and crude oil price performance
Is the good news for oil good enough?
Of course, there are two sides to the balancing of supply and demand. The United States – via fracking – has been a key source of increased supply in recent years. As shown in Figure 3, U.S. oil production did respond to the rebound in prices in the first half of last year, but supply peaked out during the second half of the year and remains roughly at the late 2018 levels.
Global production has also recovered, and in December of 2020 reached 75 million bbd, but this is close to 10 percent below productions levels of a year earlier.
Figure 3: U.S.weekly oil production and crude price
The outlook for international supplies is muddied by Saudi Arabia’s mixed signals. On 17 February, the Kingdom announced intentions to increase supply in the months ahead, but in March it indicated its intent to keep supplies stable.
The Saudis, however, have two compelling reasons to want to limit the rise in oil prices. First, they remain in conflict with Russia over its policy of supporting the Assad regime in Syria and may see softer oil prices as a means of moderating Russia’s ability to provide continued military support.
A perhaps more compelling reason is that at current pumping rates, Saudi Arabian oil reserves will not be exhausted for close to a century, so they may feel that a short-term gain in prices may have a long-term downside if it accelerates the move towards alternatives and/or energy-saving technologies.
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Electric cars casting a shade on oil
Tesla’s success at mass production of the Model 3 is signalling the growing realisation that electric vehicles are the wave of the future.
Even the major oil companies are now preparing for an electric future: Exxon and BP, among others, are planning for electric vehicle production reaching 100 million units per year within 20 years. And a strong link has emerged between Tesla stock performance and oil prices.
As shown in Figure 4, when the SPX index underperforms Tesla stock oil prices have generally headed lower. But there has been a dramatic divergence; although the SPX is making new records, so has Tesla, and it has held the relatively lofty relative position established in the wake of the pandemic.
Even if we assume the impact of COVID-19 has permanently distorted this relationship, the strong Tesla performance would seem to negate the potential for further upside in the price of crude.
Figure 4: Tesla outperformance and crude oil prices
Isn’t oil used to generate electricity?
The shift away from gasoline vehicles will, by necessity, create much higher demand for electricity.
To the degree that oil continues to be a major source of power generation, the shift to electricity should be benign for the outlook on oil prices. But, as shown in Figure 5, the U.S. EIA is projecting that the bulk of increase in electric production will come from natural gas and alternatives with only marginal growth expected in the use of oil.
The near-term prospects for oil look modestly positive as long as the pick-up in global economic activity persists, but it looks like $65 will cap the market for at least the next few months.
Indeed, the IEA projections suggest there is little upside for oil at least through 2022. although a surprise on global economic growth could allow oil to break to new highs.
The seemingly inevitable move toward electric vehicles paints a negative long-term structural picture for oil demand as energy usage is projected to shift to other sources.
Natural gas should be a relative winner from the shift to electric, given the outlook that it will be a chief source of future electricity generation. Copper is also arguably a relative winner, as it is going to take a lot of wire to transmit all the increased flow of electricity from the power plants to the consumers.
Figure 5: Projected growth in sources of global electricity production thorough 2050
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