EIA Lowers Crude Forecast; WTI Average to Match Brent

EIA notes that the current value of futures and options contracts continue to suggest high uncertainty in the price outlook. For example, WTI futures contracts for June 2016 delivery, traded during the five-day period ending March 3, averaged $37/bbl, while implied volatility averaged 50%. These levels established the lower and upper limits of the 95% confidence interval for the market’s expectations of monthly average WTI prices in June 2016 at $24/bbl and $58/bbl, respectively. The 95% confidence interval for market expectations widens over time, with lower and upper limits of $20/bbl and $81/bbl for prices in December 2016. At this time last year, WTI for June 2015 delivery averaged $54/bbl, and implied volatility averaged 46%.

The lowering of the price forecast in the most recent “Short-Term Energy Outlook” reflects oil production that has been more resilient than expected in a low-price environment and reduced expectations for oil demand growth. The resulting inventory builds are larger than previously expected throughout the forecast period, thus delaying the expected rebalancing of the oil market and contributing to lower forecast oil prices. EIA emphasizes that increased inventory builds are a major source of uncertainty in the price forecast. If global storage capacity becomes stressed, the cost of storage will rise to reflect more expensive marginal storage options such as floating inventories on crude oil tankers. Higher storage costs would tend to divert volumes into the spot market, rather than be stored, thereby reducing near-month crude oil prices. Additional uncertainty stems from the pace of global economic growth and its contribution to oil demand growth, and the responsiveness of non-OPEC producers to sustained low oil prices.

The confidence range for crude oil prices is derived using a variation of the model that is often used by financial analysts to estimate the price of options. EIA starts with options prices for WTI crude oil and uses the model to calculate the implied volatility. WTI futures contracts and options are among the more actively traded commodity derivative products, involving many producers and consumers, including refiners, airlines, trucking companies, fuel distributors, and other investors and risk-takers. The confidence interval is therefore a market-derived range that is not directly dependent of EIA’s supply and demand estimates.

On the supply side, production is relatively resilient through the forecast period because of non-OPEC investments committed to projects when oil prices were higher. Although oil companies have reduced investments, most of the cuts have been in capital exploration budgets that largely affect production levels beyond the forecast period. Russia is one example of production exceeding EIA’s expectations. Fourth-quarter 2015 production in Russia was 0.2
MMbbld higher than in the previous “Short-Term Energy Outlook,” with initial data indicating it has remained at high levels in early 2016. This higher historical production creates a higher base line that carries through the forecast period. Russia’s production is expected to increase by 0.2 MMbbld in 2016 and then decline by 0.1 MMbbld in 2017. Russia’s exposure to low oil prices has been mitigated by the depreciation of the ruble compared with the dollar, lowering Russian oil companies’ ruble-denominated production costs compared with dollar-denominated revenue, and by Russia’s taxation regime for the oil sector.

Additionally, lower expectations for global economic growth contributed to a reduction in the oil demand forecast. EIA expects global consumption of petroleum and other liquid fuels to grow by 1.1 MMbbld in 2016 and by 1.2 MMbbld in 2017. Forecast consumption is 0.1 MMbbld and 0.2 MMbbld lower in 2016 and 2017, respectively, than in the previous forecast because of lower expected growth in real gross domestic product (GDP) for the world weighted
by oil consumption. After rising by 2.4% in 2015, forecast real GDP weighted by oil consumption rises by 2.3% in 2016 and by 3% in 2017. In the February “Short-Term Energy Outlook” growth was forecast at 2.6% in 2016 and 3.1% in 2017.