Oil Surplus to Push Prices Lower

On March 16, 2020, IHS Markit reported the current crude oil situation points to the possible buildup of the most extreme global oil supply surplus ever recorded. It estimates that, if the price war continues amid a global recession and coronavirus crisis, the surplus could range from 800 MMbbl to 1.3 Bbbl in the first six months of 2020. Since 2000, the largest six-month global surplus had been during late 2015 to early 2016, when it was a cumulative 360 MMbbl.

The consultancy believes the largest 2020–21 impact on production volumes will be in the U.S., due to the fast reactivity of U.S. oil producers and the strong decline rates of tight oil wells, as crude production could fall by 2-4 MMbbld over the next 18 months.

“There has been a dizzying drop in world oil demand and a dramatic pivot in Saudi oil production policy,” said Jim Burkhard, vice president and head of oil markets, IHS Markit. “If this situation persists amidst a recession, it points to the possible buildup of the most extreme global oil supply surplus ever recorded.” Counting barrels is challenging enough under normal circumstances, but the looming imbalance on current trajectory between demand and supply is so large now that it is well beyond any typical margin of error or uncertainty about data.

IHS Markit estimates that the global oil supply surplus on a monthly basis—the amount of global oil production in excess of demand—could range from 4 MMbbld to 10 MMbbld from February to May 2020, with demand in March and April down as much as 10 MMbbld. Estimated surplus translates into an inventory build of approximately 800 MMbbl to 1.3 Bbbl in the first six months of 2020. The higher end of this range foreshadows the impact of increasing travel restrictions, reduced commuting, and the likelihood of a severe global economic slowdown continuing in the second quarter. The primary cause of this surplus is the sharp, severe drop in world oil (liquids) demand, which in the first quarter will be at least 4 MMbbld below the year earlier level. Oil price weakness is exacerbated by the recent decision by Saudi Arabia to substantially increase oil supply by 2.6 MMbbld relative to February levels. Russia has said that it can increase production by 300,000 to 500,000 bbld.

The fast reactivity of U.S. oil producers and the high decline rates of tight oil wells mean that the largest 2020–2021 impact on production volumes at low prices will be in the United States. U.S. crude oil production, if and when new tight oil drilling stops, could fall by 2 to 4 MMbbld over 18 months. The spread of the coronavirus disease 2019 (COVID-19) and related movement restrictions raise the question as to whether oil production and supply chains be impacted owing to lack of workers in key producing areas around the world.

“The last time that there was a global surplus of this magnitude was never,” Burkhard said. “Prior to this the largest six-month global surplus this century was 360 million barrels. What is coming will be twice that or more.”

The organization foresees three potential oil market scenarios. Truce and eventual demand recovery: A “supply truce” emerges involving Saudi Arabia and Russia that leads to some production restraint, but output remains above early 2020 levels. World oil demand growth returns by the third quarter with prices in the $40-$50 range;
Prolonged demand decline, no supply restraint: An unprecedented billion-barrel supply surplus emerges as global demand falls by 5 MMBbld for the year. Prices fall to the lowest levels in a generation when the surplus is at its peak. U.S. production begins a steep decline; or

Rapid recovery and reconciliation: The world economy and oil demand are in recovery mode by mid-year. Oil prices are buoyed by the restoration of Vienna Alliance (OPEC plus Russia) production restraint.

(SOURCE: The Weekly Propane Newsletter, March 19, 2020. Subscribe to receive all the latest posted and spot prices from all major terminals and refineries around the U.S., featuring a center spread of posted prices that includes hundreds of postings completely updated each week, market analysis, insightful commentary and more.)