FLASH NOTE Flash Note Oil price A market tilted towards oversupply Pictet Wealth Management - Asset Allocation & Macro Research 13 December 217 World oil demand is expected to expand at a sustained pace (+7.7 by 222) as emerging economies thirst for oil (+9.4 by 222) will more than compensate for the expected contraction in demand in advanced ones (-1.4md). Non-conventional production, in particular US shale oil, is expected to continue to play an important role in 218 and 219, forcing OPEC to keep restraining production. On balance, the oil market appears to be moving naturally toward a situation of slight oversupply in 218 and 219. The same discipline shown by OPEC and Russia in 217 will be required to ensure a repeat of this year s slight shortfall in supply and support prices at their current level. Our long-term fundamental equilibrium model shows that oil is currently fairly valued (USD58 for WTI and USD64 for Brent). The oil price equilibrium is expected to remain close to its current level (USD55 for WTI and USD61 for Brent at end-218) AUTHOR Jean-Pierre DURANTE jdurante@pictet.com +41 58 323 2452 Pictet Group Route des Acacias 6 CH - 1211 Geneva 73 www.pictet.com After the 3 November agreement between the OPEC and Russia to extend oil production cuts until the end of 218, it is worth looking again at the balance between oil supply and demand. The most recent data indicate that without continued OPEC s willingness to limit supply, the market will be naturally tilted towards oversupply in 218 and 219. Oil prices in 218 will largely depend on OPEC members and Russia remaining disciplined enough to keep production slightly below demand. In this context, we are sticking with our forecast, based on long-term fundamentals, which currently points to an equilibrium oil price of USD58 for the WTI (USD64 for Brent) and USD55 at end-218 (USD61 for Brent) A widely expected agreement between OPEC and Russia The agreement on 3 November was largely discounted by the market beforehand, and prices have moved only modestly since. On 12 December, the WTI spot price was USD57.1 compared to USD57.4 on 3 November (Chart 1). Chart 1: WTI and Brent spot price USD per barrel 12 11 1 9 8 7 6 5 4 WTI Brent 3 31/12/215: 37.1$ 11/2/216: 26.2$ 2 13 14 15 16 17 18 Source: Pictet WM - AA&MR, Thomson Reuters Unabated growth in global demand 6% since end 216 +34% since 22 June 217 World oil demand is expected to expand in the coming years at more or less the same pace as in the recent past. Based on the major energy agencies projections i, world oil demand will expand by 7.7 million barrels per day () by 222, slightly more than between 21 and 216 (+7.4), so that global demand reaches 14 in 222, up from 97 currently. 64.$/b. 57.1$/b.
However, demand dynamics vary from country to country. The expected 7.7 increase in daily demand is essentially due to expansion in emerging economies (+9.1 by 222). By contrast, the decline in demand in advanced economies (-.4 in 21-16) is expected to accelerate (-1.4 between 216 and 222, Chart 2). Emerging economies thirst for oil The strong increase expected in oil consumption in emerging economies is underpinned by three main factors: Economic growth Demography Urbanisation These factors are expected to play out to the fullest in emerging economies in the very next years, but point to lower oil consumption in advanced economies, where growth is set to decline, populations are ageing and urbanisation has more or less stalled. Rapid energy transition, notably in terms of vehicle efficiency, is a further factor pulling down oil demand. The transition towards cleaner sources of energy has been more rapid than expected in recent years, particularly in advanced economies, and is expected to continue to play an important role in the future. Chart 2: World oil demand Forecast* 1 World +7.7 8 6 Emerging +9.1 4 Advanced -1.4 2 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 1 3 5 7 9 11 13 15 17 19 21 23 25 * Based on IEA data from the OIL 217, Market Report Series, OECD/IEA 217, as computed by PWM - AA&MR Source: BP Statistical Review of World Energy, June 217 for past data Even among emerging economies, the energy outlook varies. A big gas guzzler like China has already started its own energy transition, with measures to improve the efficiency of cars and trucks already bearing fruits. As a consequence, growth in Chinese oil consumption is expected to slow in the coming decade so that China may no longer be the main driving force behind global oil demand. By contrast, India s thirst for fossil fuel is likely to accelerate and turn it into the biggest source of oil consumption growth in the future. Currently, India consumes 1.2 barrels per capita per year (bcy). One can easily imagine the potential for Indian oil consumption to grow (especially given its 1.3bn population) when one considers that oil consumption is currently 3.3bcy in China (9.1bcy in France and 22.3bcy in the US, Chart 3). 12 December 217 FLASH NOTE - Oil price PAGE 2
Chart 3: Oil demand: The 5 big gas guzzlers 25 2 15 Forecasts* US -.4 China on 26-16 trend (+2.7 ) China +1.9 1 India +1.4 5 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 1 3 5 7 9 11 13 15 17 19 21 23 25 Japan -.4 Saudi Arabia +.1 * Based on IEA data from the OIL 217, Market Report Series, OECD/IEA 217, as computed by PWM - AA&MR Source: BP Statistical Review of World Energy, June 217 for past data The importance of non-opec production The emergence of US shale oil has probably been the most important development in terms of oil supply in recent years. The ability of US nonconventional oil companies to unlock new resources and to cut production costs has helped double oil production in the US since 28, turning it into a major world player. The US is expected to become a net exporter of oil in the late 22s (Charts 4 & 5). Chart 4: World oil supply Forecasts* 1 World +5.5 8 6 Non-OPEC +3.6 4 OPEC +1.8 2 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 1 3 5 7 9 11 13 15 17 19 21 23 25 * Based on IEA data from the OIL 217, Market Report Series, OECD/IEA 217, as computed by PWM - AA&MR Source: BP Statistical Review of World Energy, June 217 for past data So, non-opec production has become a major factor in oil supply in recent years, helping explain the limited upwards potential of oil prices since 216. However, non-opec production is expected to stabilise in the next few years, so meeting additional demand may well depend in large part on spare capacity in OPEC countries, particularly in the Middle East, enabling them to exert more influence over oil prices again. 12 December 217 FLASH NOTE - Oil price PAGE 3
Chart 5: The 8 biggest crude oil suppliers 16 14 12 1 8 Forecasts* US +1.8 Saudi Arabia** +.4 Russia +.1 6 4 2 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 1 3 5 7 9 11 13 15 17 19 21 23 25 * Based on IEA data from the OIL 217, Market Report Series, OECD/IEA 217, as computed by PWM - AA&MR Canada +.8 Iraq** +.2 China -.3 Iran +.1 United Arab Emirates** +.1 ** Same trend as OPEC aggregated Source: BP Statistical Review of World Energy, June 217 for past data The US shale oil industry continues to surprise by its dynamism, with production stats regularly revised upwards. US shale oil producers have pumped out more than one million additional barrels per day in 217 (Chart 6). Chart 6: US shale oil production mio barrel/day 7.3 6.8 +1.2 6.3 +1.9 5.8 5.3 4.8 15 16 17 Source: Rystad Energy, Bloomberg, Pictet WM - AA&MR World oil balance: oversupply ahead OPEC members have been particularly disciplined in applying the production cuts agreed at end 216. As a result, in 217, worldwide oil production has stalled, despite a sustained global economic recovery. The 3 November agreement was particularly important as, without it, the prospect loomed of oversupply in 218 and 219 (Chart 7). Assuming that OPEC and its non-opec partners stick to the 3 November agreement and taking into account increased non-conventional production, total oil supply could increase by 1.5 in 218. Accordingly, given our forecast for a rise in oil demand next year, there could be a slight shortfall in supply (-.3 compared to -.5 in 217), potentially supporting oil prices. However, there are some caveats. It may be too much to assume that OPEC members will remain as disciplined at they have been. In particular, the fruits of heavy Russian investments are likely to appear in 218. The prospect of losing market share will create a strong incentive for Russia to renege on the production agreement. Moreover, central government control 12 December 217 FLASH NOTE - Oil price PAGE 4
over producers is notoriously looser in Russia than in the OPEC countries. All in all, despite the 3 November agreement, OPEC/Russian production risks being slightly higher in 218 than in 217. Chart 7: Oil supply-demand balance mb/d 13 Current supply: 97.2 Forecasts mb/d 2. 11 1.5 99 97 95 93 91 Oil demand Oil supply Supply and balance with OPEC-Russia agreement 1..5. 89 -.5 87 85 Balance (rhs) -1. 83 7 8 9 1 11 12 13 14 15 16 17 18 19 2 21 22-1.5 Based on IEA data from the OIL 217, Market Report Series, OECD/IEA 217, as modified by PWM - AA&MR Oil price close to fair value With so many structural changes in both supply and demand in recent years, forecasting oil prices has been particularly challenging. Forecasters that try to encompass all the factors in a model risk trying to miss the latest and most important factor for price trends. That is why we prefer to rely on a parsimonious model based on a long-term fundamental relationship that has remained stable since the 198s between oil price, world economic growth and the US dollar. Since its inception, the model has proved to be quite a reliable indicator for medium-term oil price movements. Chart 8: WTI price equilibrium USD per barrel 14 Assumptions : World GDP growth: 3.6% in 217 and 3.7% in 218 12 1 US inflation: 2.1% in 217 Oil price (WTI) Current equilibrium: 58$ 8 6 4 $ down 1% $ flat $ up 1% 2 Long-term equilibrium* 88 89 9 91 92 93 94 95 96 97 98 99 1 2 3 4 5 6 7 8 9 1 11 12 13 14 15 16 17 18 Current price 57.1$ * Based on co-integration relationship between oil price, US dollar and world economic growth Source: Pictet WM - AA&MR calculation based on Thomson Reuters data The conclusions we reached in our Flash Note of 8 November (WTI likely to remain close to USD55) remain valid. As the oil price is currently very close to its equilibrium (USD58 for WTI), significant pressure, either upwards or downwards, appears to be limited at this stage. A temporary gap between the spot and equilibrium price is always possible due to factors that are not encompassed in the model (such as geopolitical tensions). However, even in such cases, the spot price is likely to become strongly attracted towards its equilibrium and converge towards it after a while, as has occurred regularly in the past (Chart 8). 12 December 217 FLASH NOTE - Oil price PAGE 5
On a 12-month horizon, based on our world GDP forecast and assuming a stable USD, the long-term equilibrium should ease back towards USD55. Only a significantly weaker US dollar (which is not in our central scenario for 218) would likely push the long-term equilibrium above the USD6 threshold (see table). Notice: This marketing communication is not intended for persons who are citizens of, domiciled or resident in, or entities registered in a country or a jurisdiction in which its distribution, publication, provision or use would violate current laws and regulations. The information, data and analysis furnished in this document are disclosed for information purposes only. They do not amount to any type of recommendation, either general or tailored to the personal circumstances of any person. Unless specifically stated otherwise, all price information is indicative only. No entity of the Pictet Group may be held liable for them, nor do they constitute an offer or an invitation to buy, sell or subscribe to securities or other financial instruments. The information contained herein is the result neither of financial analysis within the meaning of the Swiss Bankers Association s Directives on the Independence of Financial Research, nor of investment research for the purposes of the relevant EU MiFID provisions. All information and opinions expressed in this document were obtained from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to its accuracy or completeness. Except for any obligations that any entity of the Pictet Group might have towards the addressee, the addressee should consider the suitability of the transaction to individual objectives and independently assess, with a professional advisor, the specific financial risks as well as legal, regulatory, credit, tax and accounting consequences. Furthermore, the information, opinions and estimates in this document reflect an evaluation as of the date of initial publication and may be changed without notice. The Pictet Group is not under any obligation to update or keep current the information contained herein. In case this document refers to the value and income of one or more securities or financial instruments, it is based on rates from the customary sources of financial information that may fluctuate. The market value of financial instruments may vary on the basis of economic, financial or political changes, currency fluctuations, the remaining term, market conditions, the volatility and solvency of the issuer or the benchmark issuer. Some investments may not be readily realizable since the market in the securities can be illiquid. Moreover, exchange rates may have a positive or negative effect on the value, the price or the income of the securities or the related investments mentioned in this document. When investing in emerging countries, please note that the political and economic situation in those countries is significantly less stable than in industrialized countries. They are much more exposed to the risks of rapid political change and economic setbacks. Past performance must not be considered an indicator or guarantee of future performance, and the addressees of this document are fully responsible for any investments they make. No express or implied warranty is given as to future performance. Moreover, forecasts are not a reliable indicator of future performance. The content of this document can only be read and/or used by its addressee. The Pictet Group is not liable for the use, transmission or exploitation of the content of this document. Therefore, any form of reproduction, copying, disclosure, modification and/or publication of the content is under the sole liability of the addressee of this document, and no liability whatsoever will be incurred by the Pictet Group. The addressee of this document agrees to comply with the applicable laws and regulations in the jurisdictions where they use the information reproduced in this document. This document is issued by Banque Pictet & Cie SA. This publication and its content may be cited provided that the source is indicated. All rights reserved. Copyright 217. Banque Pictet & Cie SA is established in Switzerland, exclusively licensed under Swiss Law and therefore subject to the supervision of the Swiss Financial Market Supervisory Authority (FINMA). Distributors: Banque Pictet & Cie SA, Pictet & Cie (Europe) SA EQUILIBRUM OIL PRICE:12-MONTH HORIZON US DOLLAR (real trade-weighted) ($/barrel) -1% % +1% World GDP (217) 3.2% 6 52 46 3.6% 64 55 48 4.2% 68 58 51 Source: Pictet WM - AA&MR calculation based on Thomson Reuters data i International Energy Agency, https://www.iea.org/ OPEC, http://www.opec.org/opec_web/en/ US Energy Information Agency, https://www.eia.gov/ 12 December 217 FLASH NOTE - Oil price PAGE 6