Crude supply — what if no-one blinks?

There is a great, unspoken “what if” in the stand-off between Opec’s strategists and the rest of the world’s oil producers — what if no-one blinks?

What if Arab Mideast Gulf Opec producers’ pockets are deep enough and their zest for domestic subsidy reforms is strong enough to ride out the storm? What if the US shale industry continues on its downward cost trajectory to a point where $40/bl oil is as A-ok in North Dakota and Texas as it is in Saudi Arabia? What if none of the Opec troupe falls into chaos, bankruptcy and plunging production? (Libya’s demise pre-dated the price crash, so its perdition is already a given.)

In other words, what if there is no supply response, or not enough of a response from producers to rebalance the market, at least in the way the market has come to expect over the last 15 years? Supply has to play a part, because demand alone cannot absorb all of the oversupply in world oil markets.

The IEA’s most recent Medium Term Market Report said lacklustre demand was part of the reason for the 2014-15 price collapse. It said this suggested that lower prices would only go so far in boosting economic growth and lifting oil demand. It has been revising these views quite dramatically, but still only sees demand growth of 1.7mn b/d this year and 1.4mn b/d next year. That is not enough to balance the market.

Oil demand is driven primarily by economic growth, and it’s here that things get tricky. Some GDP data are being revised up, in the US for example. But that’s not the case everywhere. Chinese growth rates — and their lack of correlation with Chinese apparent oil demand — have been at the centre of a lot of debate about oil market equilibrium over the past few months.

The OECD, today, called global growth prospects “sub-par”, and said prospects for increased growth are being stymied by stagnating trade, deteriorating financial markets and, above all, fear — fear of a sharper-than-expected Chinese slowdown; fear of a US interest rate rise; fear that the comfort blanket of QE will be whipped away to expose the economy’s new clothes.

Opec, merrily pumping away like never before, is the more down on demand than anyone else, especially when it comes to the emerging markets that have been the bedrock of oil demand increases over the past 15 years.

Prospects for the BRIC nations – the acronym coined by one of Goldman Sachs’s big brains back in 2001 – are waning right now. In 2003, Goldman Sachs said the BRICs could become a much larger force in the world economy by 2050. In fact, they already have and there is scope for more in the next 35 years, but is too much being put on some fragile shoulders?

Opec cautions that China’s slowdown has become more pronounced, and Brazil and Russia “are now both forecast to face a considerable recession this year”. True, Opec sees “a healthy trend” in India. But with three of four BRICs struggling, Opec is relatively cautious about oil demand.

Large parts of the de-industrialised, environmentally aware OECD can no longer be relied on for oil demand growth. Even if their economies grow, fuel efficiency and switching in the EU and Japan mean oil consumption may not respond. The US is different, and it is leading an OECD revival in oil deliveries that marks out this year from most of the 21st century so far. The US response is caused by a mixture of economic growth and consumers’ direct link to global oil markets through pump prices, without the high taxes that deaden the impact of wholesale price changes elsewhere in the OECD. Lower prices have put a rocket under demand growth in the year to date, but this is still a market that needs someone to blink.