EIA’s recently released November Short-Term Energy Outlook (STEO) projects that Brent crude prices will average $83/barrel in 2015, $18/barrel lower than last month’s outlook for 2015. STEO projects prices to remain in the $80 to $90 per barrel range next year, bottoming out under $82/barrel in the second quarter when balances are loosest and then increasing during the second half of 2015 to average $86/barrel in the fourth quarter. Even with the downward revision to the STEO price forecast, second to fourth quarter 2015 oil price projections remain within the market-derived 95% confidence interval published in the September STEO before the recent fall in oil prices.
The lower price forecast in the November STEO reflects significant changes to the global oil balance. Compared to last month’s outlook, 2015 global liquid fuels demand in the November STEO declines by 200,000 barrels per day (bbl/d) to average 92.5 million bbl/d, reflecting a weaker global macroeconomic outlook. In the November STEO global production increases by 200,000 bbl/d to 92.9 million bbl/d in 2015, primarily due to a smaller forecast decline in Saudi production.
As previously discussed in TWIP, the combination of robust U.S. production growth, a return of disrupted Libyan production despite recent setbacks, weakening expectations for the global economy – particularly in China – and seasonally low refinery demand have weighed on oil prices. More recently, indications from Saudi Arabia that it will not operate as the unilateral global swing supplier have put further downward pressure on traders’ views of the market. Signs of willingness of other OPEC members to trim production have been scarce. Together, these conditions point to a much looser global supply/demand balance in 2015. However, actual price outcomes reflect a number of highly uncertain and inter-related factors, particularly OPEC production, global oil demand growth, and the responsiveness of marginal production – especially U.S. shale – to lower prices.
The market assessment of these factors is reflected in the wide market-derived confidence interval for crude oil prices implied by the value of futures and options contracts. Options written on West Texas Intermediate (WTI) futures contracts offer insight into market participants’s assessment of possible price movements. Note that the Brent options market is not sufficiently liquid to provide meaningful information on implied volatility beyond the prompt month. As of the five-day trading period ending November 6, implied volatility for the February 2015 WTI futures contract averaged 28%, resulting in a calculated 95-percent confidence interval of $63 to $99 per barrel.
Changes in the forecast of Saudi Arabian oil production are crucial to the revised outlook and a major source of uncertainty in the year ahead. Saudi Arabia has indicated interest in preserving market share rather than unilaterally carrying the burden of cutting production to balance the global oil market. In addition to numerous statements by high-level Saudi officials downplaying recent price declines, the Kingdom has maintained robust production past the peak summer domestic demand season, choosing to reduce the Official Selling Price (OSP) of its crude to maintain market share rather than scale back production to balance increasing supply from the United States and Libya.
Taken together, these actions send a message ahead of the November 27 OPEC meeting indicating that members cannot continue to expect Saudi Arabia to balance the market alone, providing at least the potential for shared OPEC production cuts while simultaneously shifting pressure onto marginal producers to cut production to accommodate increasing supply from elsewhere.
As a result, in the November STEO EIA has revised the forecast decline in 2015 Saudi production. Output is now expected to remain above 9 million bbl/d throughout 2015. While the STEO still expects Saudi Arabia to cut production from current levels, the outlook takes into account the Kingdom’s recent emphasis on maintaining market share. With some of the lowest-cost-per-barrel production in the world, and cash reserves approaching $1 trillion, Saudi Arabia is better positioned to withstand a lower oil price than other producers and can make up some of the lost revenue from lower prices by maintaining supply volumes.
With a looser supply/demand balance weighing on prices, STEO expects marginal producers will be unable to meet previous expectations for supply growth. The current price outlook does not support new development of the most expensive, marginal barrels such as Arctic, ultra-deep water, and some oil sands. However, given the long lead time and substantial investment required, these types of projects are unlikely to be affected within the 2015 STEO forecast period. The short timeframe between the start of drilling and first production from U.S. shale wells make them the first production likely to be impacted.
However, shale production costs have declined rapidly as techniques improve and infrastructure develops, and in a falling oil price environment drilling and completion costs will fall, making these wells cheaper to develop. Additionally, the most marginal, inefficient producers account for a disproportionally small volume of production. During the next several months, hedging, sunk cost calculations, and redeployment of rigs from more speculative plays to the most productive areas will mitigate much of the effect of lower prices. However, STEO expects that the impact from lower oil prices will increase as time passes, with the level of U.S. shale production in the fourth quarter of 2015 expected to be 100,000 bbl/d lower than forecast in last month’s STEO. Nevertheless, U.S. crude oil production is still expected to increase by 850,000 bbl/d in 2015 to average 9.4 million bbl/d.