The Fuse

IEA: Get Ready for a Price Spike

by Matt Piotrowski | March 06, 2017

With oil prices remaining relatively low and shale production picking back up, oil markets appear relatively stable, but the current situation isn’t going to last forever.

The International Energy Agency (IEA), in its latest Medium-Term Oil Market Report, released Monday, broadcast dire warnings, suggesting that the market will tighten considerably after 2020, with sharp price spikes and increased volatility—despite continued rapid growth in shale.

The IEA says the market will tighten considerably after 2020, with sharp price spikes and increased volatility—despite continued rapid growth in shale.

Speaking at a press conference at CERAWeek by IHS Markit in Houston, IEA Executive Director Fatih Birol emphasized the importance of increasing upstream investment while also taking demand-side measures to cushion against the looming market crunch. “For U.S. energy independence, as much as one wants to see domestic production growth…efficiency is also part of the game,” Birol told reporters in response to a question about the possibility of the U.S. government easing fuel economy regulations.

“For U.S. energy independence, as much as one wants to see domestic production growth…efficiency is also part of the game.”

In the agency’s reference scenario, it forecasts global supply rising by some 5.6 million barrels per day (mbd) over the next five years, but demand increasing by a higher amount—7.3 mbd. Against this backdrop, global spare production capacity will decline “big time,” Birol said, putting it at dangerous levels, close to levels in 2008, when prices spiked to $147 per barrel.

Peak demand—forget about it

Birol emphasized that oil demand will not peak anytime soon, despite numerous reports that fuel efficiency standards and alternative vehicles will slow growth and ultimately cause consumption to decline.

In a reflection of the challenges the global oil market will face in the coming years, some one-third of demand growth will come from trucks in Asia. For this portion of the transportation sector, there is no immediate substitute. The jet fuel and petrochemical markets, where a good portion of demand growth will also occur, lack substitutes, too. With that in mind, the enthusiasm surrounding shifts in transportation should be kept in check. Oil demand is expected to pass the significant threshold of 100 mbd in 2018.

Not enough investment outside the U.S.

While demand will put pressure on prices, so will lack of investment on the supply side. Birol said investment is currently 25 percent lower than what it needs to be in order to meet rises in demand and offset declines in current fields. The one bright spot, U.S. shale, should keep the market in check for the next couple of years, but limited outlays over the past few years during the current price slump will eventually bite.

Investment is currently 25 percent lower than what it needs to be in order to meet rises in demand and offset declines in current fields.

Of the growth expected over the next five years, roughly 30 percent will come in the U.S. The IEA sees U.S. crude oil supply rising by 1.6 mbd over the next five years. “We are now witnessing a second wave of U.S. shale growth,” Birol told reporters, noting how U.S. light, tight oil is the only area that can respond swiftly to prices rises—as is the case now. U.S. shale is back to 9 mbd after falling to 8.5 mbd last year.

Despite shale’s growth, there is a “significant risk of prices rising sharply starting 2020, unless significant new projects are sanctioned soon.” Outside of the U.S., the biggest growers will be non-OPEC suppliers Brazil and Canada, as a result of projects sanctioned before the price fall. In OPEC, Iraq will see the largest gains. Birol’s main worry is that the call on OPEC crude—the amount needed to balance the market—will rise in coming years without enough upstream investment. This situation will create different trade flows, with Brazil and Canada sending volumes to Asia, the region seeing the largest demand growth, in order to fill the gap. “Trade routes will lengthen as Asia needs more oil but the Middle East can’t meet it,” said Birol.

“Trade routes will lengthen as Asia needs more oil but the Middle East can’t meet it.”

It’s not all doom and gloom—yet. For the next couple of years, the market looks to be well supplied with strong non-OPEC growth and inventories—despite falling—remaining above the five-year average. Furthermore, in a case where oil trades at $80 per barrel, U.S. light, tight will increase by an enormous 3 mbd in the next five years, almost double the base case scenario. Still, looking further out, the IEA is envisioning a completely different market than the one we see today.

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