Medium Term Oil Market Report: An Oil Market Transformed

On February 10, during a pivotal time in oil markets, the International Energy Agency released its latest oil market outlook for the next 5-7 years—four months in advance of its normal publication schedule. The Medium Term Oil Market Report is an important annual companion to IEA’s Monthly Oil Market Report, which focuses on supply and demand projections, as well as issues like global bunkers and biofuels. This year’s early release comes in the wake of a series of seismic shifts that have taken place since October: oil’s price collapse, OPEC’s refusal to cut production despite conditions of global oversupply, and the resulting price test of U.S. shale. IEA’s report is comprehensive, clocking in at 140 pages long. Here are the key takeaways.
  • The underlying conditions of the oil market that have remained fundamentally unchanged in recent decades no longer apply. The main reason, American light tight oil production, is about more than a sudden production surge. Rather, it is the short lead times for this oil to come online that marks the largest departure from non-OPEC oil production (deepwater, arctic, oil sands, and other megaprojects) in years past, which required a number of years rather than a number of months to come online.
  • A price rebound, in IEA’s terms, “seems inevitable.” The report makes clear that understanding the return of high oil prices is not the challenge—it is a given.
  • Global oil demand will not match the growth rates anticipated just prior to the 2008-2009 financial crisis, but will remain above current lows in the period through 2020. IEA’s current projections are visualized below.

  • In IEA’s explanation, no oil market shock is fully unprecedented. Massive shocks have rocked the system at least every ten years since the 1970s. In addition to the two OPEC crises that took place that decade, there were massive shocks in 1986, 1998, and 2008. Destabilizing imbalances in oil production and supply should be considered the rule, not the exception. What differentiates this particular shock, however, is that it is both supply and demand driven, while earlier shocks were generally one or the other.
  • Oil market economists work on a general rule of thumb—that the more severe a shock, the more rapid a correction. This appears to be true in this most recent case. Following many years of continued high prices, “a day of reckoning has arrived.” However, since non-OPEC supply is more elastic than ever before, the market rebalancing will occur relatively swiftly, barring a major geopolitical disruption.
  • Aside from U.S. shale, concerns of substantial and destabilizing increases in OPEC supply that commentators noted frequently before the global price collapse are still alive and well. Notably, Iraq’s oil output reached 3.7 mbd in December 2014 despite the harsh investment climate and the continued threat of the Islamic State (although Iraq’s output has dropped off since December, the important consideration is that the production capacity is in place). There is still the possibility that sanctions on Iran could be lowered or removed, or a return of Libyan supply, although neither of these outcomes is especially likely at this particular time.

  • The impact that low oil prices are expected to have on economic growth—and, as a consequence, global oil demand—is a significant wildcard in the current market. In IEA’s estimation, because part of the current supply glut is driven by sluggish global oil demand, the agency expects low oil prices to have a middling effect on the global economy. Part of this is because some of the largest drivers of global oil demand growth in recent years has been from major oil exporting economies, which are hit hard by the current price decline. Furthermore, the sustained record oil prices of recent years have already incentivized most of the world’s developed economies, as well as China, to reduce the role of oil in their manufacturing and fuel mix. In other words, high oil prices have made the global economy generally less oil intense as a whole.
  • In spite of the 50 percent collapse of oil prices, IEA still expects global oil supply to increase by 5.3 mbd—or about 5 percent—over the next 6 years. Of this 5.3 mbd, IEA sees two thirds of production growth coming from non-OPEC producers, with OPEC production only increasing 200,000 b/d over the projection period, contributing a total increase of 1.2 mbd by the end. However, the agency also anticipates significant constrain on upstream and capital investment, and the biggest wildcard is U.S. shale production. Although shale production itself in the United States is elastic and can ramp up and down quickly, the question remains how much appetite investors will have to support shale producers, and without access to debt, this form of oil production could have trouble ramping back up when oil prices inevitably increase again. In IEA’s words, U.S. shale’s “short lead and pay-back times, rapid well-level decline rates, and treadmill-like investment requirements make it far more price elastic than conventional crude.”
Finally, these characteristics of U.S. shale and the rapid decline of the rig count, as well as OPEC’s decision to refrain from cutting production in November of last year, suggest that shale oil is the new balancing force on the global oil market. However, we still have much to learn about the financial and technological instruments that underpin this extraction technology. That’s what makes this one of the most unpredictable and challenging times in the history of the oil market.