The state of crude prices: markets likely to remain oversupplied well into 2017

April 2016 | Evelina Pagkalou, Elif Kutsal

Excess supply, low demand, and strong US dollar crushing crude prices

After almost four years of crude oil prices consistently over $100/bbl, prices entered a downward spiral in Q4 of 2014 and most of 2015. The combination of excess supply, lower-than-average demand, and a strengthening US dollar proved enough to push prices, even briefly, below the $30/bbl mark.

We entered 2016 with record-high inventories, a production-consumption imbalance of over 1.5 million bbl/d and a trade-weighted USD index that hasn’t been this high since 2003. Both WTI and Brent crude are trading now at 35% of their $115/bbl and 107/bbl respective peak value in June 2014.

Exhibit 1

Supply-demand equilibrium unlikely for another 24 to 36 months under status quo case

Crude prices will not fully recover until the markets are convinced that the underlying fundamental imbalance has been dealt with. Under current conditions, it is unlikely that the crude oil market will return to a sustainable supply-demand equilibrium for at least another 24 to 36 months without a radical shift in OPEC behavior.

For equilibrium to be achieved, certain conditions are a prerequisite: production and consumption of crude oil need to meet in the middle and oil inventories need to return to business-as-usual levels. Under a status quo case, we expect that the balancing of market fundamentals will take 18 to 24 months, while the drawdown of growing inventories could add another 12 to 16 months. Pending market dynamics, recovery could take even longer.

The road to recovery could also take multiple forms. For example, continuous underinvestment in the coming months could lead to a non-linear recovery, where we would face undersupply before the market finally balances.

Exhibit 2

Liquids demand growth expected to stay below 1 million bbl/d in the short term

Liquids demand growth in the short-term is expected to stay below 1 million bbl/d, as the effect of the price decline on demand subsides. Demand is expected to be further undercut by the potential removal of subsidies in large oil consumer markets as well as by a slowdown in Chinese GDP as the country struggles with falling productivity and increasing debt levels.

On the production side, we anticipate global supply to finally decline for the first time in 2016, mostly due to further declines in US oil production. As the market imbalance slowly softens, total liquids should return to a conservative growth in 2017, driven equally by oil and other liquids. Accelerated decline rates in mature basins are projected to drive down non-LTO non-OPEC production from 2017 onward. An anticipated return of growth in US LTO and Iran should offset this decline, but recent cuts in field maintenance risk leading to even higher decline rates, especially if prices stay depressed for long.

Recovery subject to multiple risks

Current price volatility levels indicate that recovery is subject to multiple risks. We see demand facing mostly upside risk if emerging economies manage to move in a timely manner to productivity-driven economies.

On the supply side, there are risks in both directions, since a world of continuous oversupply—or underinvestment leading to undersupply—are both plausible scenarios. Major concerns are explored in the chart below.

Exhibit 3

The real challenge going forward will not only be to achieve a slowdown in supply growth, but to avoid further market shocks and ensure that a strengthened oil price will not lead us back to overproduction of oil. Current market conditions indicate that 2018 might also be a year of relative oversupply, but markets may suffer from underinvestment in the years to come.


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About the authors

Evelina Pagkalou is a senior analyst and Elif Kutsal is a specialist, both with Energy Insights in McKinsey's London office.