U.S. shale continues to lead global growth in oil production among non-OPEC members, easily covering projected increases in demand in the coming year. While this could make it difficult for benchmark crude oil prices to break out of the $60 to $65 a barrel range, where they’ve stalled for several months, it’s good news for consumers.
American drivers have, on average, paid well below $3 a gallon for regular unleaded gasoline over the past year, according to the U.S. Energy Information Administration (EIA). Low gas prices have contributed to solid economic performance, with 2.1% annualized GDP growth in the third quarter.
The question is whether this period of moderate energy costs is sustainable? In short, yes. That is, at least for another year. While there are threats to oil price stability, most risks are to the downside, ultimately benefiting consumers, but could prove disappointing for U.S. energy companies.
Russia and Saudi-led OPEC producers continue to demonstrate their commitment to higher oil prices by cutting production to avoid a plunge in prices. The so-called “OPEC+” group will enter its fourth consecutive year of production cuts in 2020.
Recently, the group agreed to deepen production cuts by an additional 500,000 barrels, removing a total of 1.7 million barrels a day from the market. A further slash of 400,000 daily barrels in Saudi production is also possible but is contingent upon members doing a better job of complying with the production-cut agreement.
The International Energy Agency (IEA) contends that because the rise of non-OPEC oil supply has been slower than original estimates, coupled with the fact that the OPEC+ production cuts are greater than anticipated, the deficit my result in an unbalanced market. Especially in the first half of 2020.
Non-OPEC supply, led by the U.S. shale, is forecast to grow by 2.1 million barrels a day in 2020, according to the IEA's latest monthly Oil Market Report. That is 200,000 barrels a day lower than the Paris-based agency projected in November, reflecting the recent slowdown in drilling activity and investment in U.S. shale.
Global demand for oil is set to increase by 1.2 million barrels a day next year. That’s a lower growth rate than previously anticipated, which means the world will need 900,000 fewer barrels of oil every day from both OPEC and non-OPEC producers alike.
The additional production cuts agreed to by the OPEC+ group earlier this month in Vienna are a response to IEA's lower growth expectations. However, the additional cuts are not enough to avoid a build-up of inventories.
Even if OPEC and its partners keep the output cut in place beyond its spring expiration date and through the end of 2020, increased production from other parts of the world, primarily from U.S. shale, will still cause a build-up of inventories, according to the EIA. More inventory points to lower prices.
Forecasts call for a decrease in international oil prices, on average, from $64 in 2019 to $61 a barrel in 2020, and prices on the U.S. benchmark West Texas Intermediate (WTI) averaging $5.50 lower than the Brent price in the new year.
The spending plans of international oil companies are already starting to reflect the new bearish outlook. Oslo-based consultancy Rystad Energy is anticipating overall global investment in exploration and production (E&P) to decrease by approximately 4%.
Investment in shale oil is expected to contract more than other oil basins — by almost 12%. Investor demands for higher returns mean shale producers need to raise prices to improve their margins before justifying higher investment rates.
The problem for OPEC+ is that the slowdown in U.S. shale may not happen fast enough for its members, who are growing tired of giving up market share and subsidizing American producers.
OPEC leader Saudi Arabia wants higher prices to support the record IPO of its state oil giant Aramco. They also need to shore up fiscal deficits and are losing patience working to secure supply cuts while other OPEC+ members continually fail to comply with agreements.
Iraq, Nigeria, and Russia have notably fallen short of full compliance with reduction quotas in recent months, a issue that has not gone unnoticed by other OPEC members. Saudi Arabia took an unusually aggressive stance at the OPEC+ meetings earlier this month, threatening to boost oil production unilaterally if other cartel members continue to defy the output restrictions.
The Saudi's tough talk raises questions about the overall cohesion of the OPEC+ alliance. Flooding the market with oil and reducing prices is not beneficial to any member of the cartel. However, with the lowest extraction costs in the world, Saudi Arabia is best-equipped to handle a low-price scenario.
The main concern for OPEC+ members remains the continual loss of space for its oil in the global market due to the growth of U.S. shale.
The IEA sees space in the market for 29 million additional incremental barrels a day of oil from OPEC countries in 2020. That number continues to follow a downward trend from an estimated 29.9 million barrels a day in 2019 and 30.8 million in 2018.
The growth in shale output should slow further as access to capital tightens – IHS Markit predicts growth will drop to 440,000 barrels a day next year and flatten further in 2021 – but U.S. producers aren’t going to go quietly into that good night.
Rystad believes the shale sector will continue to expand, even under lower prices and shrinking investment, well into the early part of the next decade. Rystad's analyst believe WTI prices would have to fall to an average of $45 a barrel to have a sustained impact on America's prolific shale plays.
Therefore, 2020 will be a critical year for oil markets. If U.S. shale continues to defy expectations and register production growth close to the forecasted 900,000 barrels a day – as EIA forecasts – the cohesion of the OPEC+ group will face continued challenges.
Those challenges could translate into an increasingly unpredictable future for Saudi Arabia and, possibly, an end to the era of OPEC and Russia production deals. If that happens, all bets are off for what the future holds for oil markets for 2020 and beyond.
