IHS Markit: Oil price outlook strengthens as markets approach recovery pivot point

Oil markets have returned to relatively stable ground with Brent prices within a narrow $40-45/bbl range and could conclusively pass the $50/bbl mark in second-half 2021, according to Roger Diwan and the IHS Markit Energy Advisory Service.

The IHS Markit Brent price outlook has been revised upward to an average price of $42.35/bbl in 2020 and $49.25/bbl in 2021—up $7.09/bbl and $5.25/bbl, respectively, from IHS Markit’s outlook in May.

Emerging from the worst of the COVID-19 outbreak, oil markets are now at a delicate pivot point as they transition to Phase II of the IHS Markit Three Phases of Oil Markets Recovery, IHS said (OGJ Online, May 12, 2020).

“The record cuts set in motion in May and June by Saudi Arabia and its OPEC+ partners played a pivotal role in accelerating the improbable rebalancing of global oil markets. With demand recovering from April lows and after giving markets an extra month to find their footing, these exporters have now moved from managing the immediate surplus of the crisis towards managing the recovery,” said Diwan, vice-president financial services, IHS Markit.

Phase II of the recovery (the “just-in-time oil market” phase) is a delicate transition phase in which surplus inventories are worked down in parallel with rising supply as spare supply capacity returns from Vienna Alliance and North American producers.

OPEC+ and US are bringing back over 4 million b/d of production in July and August. Meanwhile, the global demand recovery is showing clear signs of plateauing and Chinese crude buying has begun to soften.

Barring a large second wave of COVID-19 cases driving widespread economic shutdowns, IHS Markit expects Brent will stay within a $40-$47/bbl price band on average over the next 4 quarters.

This stabilization period will make way for the more structural stage of the recovery process, wherein the progressive normalization of demand and OECD commercial stocks allows a return of most spare capacity in Russia and in the key producing countries in the Gulf. This could start as early as second-half 2021, when Brent prices could conclusively pass the $50/bbl mark.

“The recent display of restored harmony among OPEC+ heavyweights Saudi Arabia and Russia illustrates that the strategic debate within the group over price levels and market share has time to run.”

“As long as prices hold in the current range, demand concerns will likely help keep the agreement on course. When prices surpass $50/bbl, potentially lifting capital spending in the US higher, that is when changes to the tenor of the discussion, and the divergence of interest could start to play out,” Roger Diwan said.

The three phases mentioned by IHS Markit are:

The crash correction (second-quarter 2020): The balancing process is well under way: shut-ins of supply, managed or unmanaged, have started to materialize in April and May, and 13-15 million b/d of crude production will likely be removed from the supply stack in the next 2 months while demand is showing some improvement from the abyss it reached in the second week of April.

The massive inventory overhang amassed onshore and offshore over the past few months will weigh heavily on markets and will not register material declines until late June or July.

The just-in-time oil market (third-quarter 2020 to first-half 2021): Prices will be governed by the unstable balance of an uncertain demand recovery and the record amount of supply on the sidelines. The length of this cycle will largely depend on the shape of the pandemic over the next year and the feedthrough to behavior and economic activity around the world. 

While the impact of testing, tracking, and vaccinating against this virus may seem indirect on the surface, they will be the most important elements in providing a predictable future for the oil industry.

Structural recovery (second-half 2021): Demand comes back to 96-98% of pre-COVID-19 levels and the progressive de-stocking of the oil supply chain allows a large share of productive capacity on the sidelines to come back into the market. Barring a second wave of the pandemic, this recovery could start to materialize a year from now. This phase could set the stage for a market squeeze in the medium-term as supply destruction hinders the ability of supply to keep up with recovering demand.