By Timothy Fox
The focus for oil traders has turned back to fundamentals, such as the poor global economic outlook
Oil markets have more than reversed the gains they made following the Abqaiq and Khurais attacks, as the initial concerns about the impact on supply gave way to reassurance that it won’t be interrupted as much as first feared.
With contracts now around 3 percent below their pre-Aramco attack levels, it is the poor outlook for the global economy and how this will feed into demand for oil that is showing itself to be the greater determinant of prices.
With markets having quickly adjusted to the supply implications of the drone attacks on Saudi Aramco, they have quickly moved on to focus on the bigger warning signs about slowing demand growth and the potential for a return to stock-builds in 2020.
The International Energy Agency’s director general has openly cautioned the agency may lower its demand forecast for 2019 as the impact of weaker economic growth becomes more apparent in oil markets. However, with 2019 mostly now a matter for historians, the outlook for 2020 becomes much more critical.
All three agencies (the U.S. Energy Information Administration, Organization of the Petroleum Exporting Countries and IEA) expect an acceleration in demand growth for 2020, with the EIA forecasting the fastest improvement (0.9m barrels a day in 2019 to 1.39m b/d in 2020) while OPEC is projecting much more modest growth.
All of the agencies are likewise projecting faster non-OPEC supply growth in 2020.
Part of the consensus view for faster oil demand growth next year is based on fuel switching in the global shipping industry as a consequence of IMO 2020 regulations taking effect from January.
Lower viscosity fuels - whether marine gasoil or low sulphur fuel oil - imply greater volumes required given the size of engines remaining unchanged. However, it is uncertain how much of an uplift IMO 2020 will provide to oil markets considering how weak global trade remains.
In the first seven months of 2019 trade growth has been negative on average, according to the CPB World Trade Monitor, and the slowdown has been accelerating.
The World Trade Organization (WTO) recently slashed its estimate for trade growth this year by more than a half, saying that it expected trade volumes to grow by just 1.2 percent in 2019, down from the 2.6 percent it predicted in April. New tariffs from the US on EU-origin goods will add a further drag on global trade growth beyond the reciprocal US-China tariffs already in force.
The first reports to assess the impact of the Abqaiq and Khurais attacks and their implications for global spare capacity will also be an important test for oil markets. In September the IEA estimated total OPEC spare capacity at 3.21m b/d of which 2.27m b/d was held in Saudi Arabia. In past periods of oil market stress Saudi Arabia has regularly increased production to keep balances steady.
During the 1990-91 Gulf War Saudi Arabia increased production to compensate for the disruptions to supplies from Kuwait and Iraq. In 2011-12 as the civil war in Libya escalated and Iran came under US and EU sanctions Saudi Arabia also stepped up production to offset the drop in output.
But doubt over Saudi Arabia’s ability to adjust production in response to unplanned outages will contribute to markets pricing in tighter overall balances, even if headline numbers are largely unaffected.
Aramco has reportedly restored capacity to over 11m b/d since the attacks and it expects to hit 12m b/d by the end of November. A lower estimate for Saudi’s spare capacity will raise anxiety over how well oil markets could cope with another shock to supply: the EIA already estimates unplanned outages in OPEC countries at over 2.5m b/d, near recent highs.
While current demand conditions don’t warrant prices pushing higher in the near term, the market should not become complacent over the limited capacity of producers to respond to sustained outages.