What’s Driving Our Long-Term Forecast For Oil Prices?

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RDSA: Royal Dutch Shell logo
RDSA
Royal Dutch Shell

We recently revised our long-term crude oil price forecast in view of the changed supply-demand outlook, primarily driven by increasing prospects of the finalization of the Iran nuclear deal and a slower than expected deceleration in the U.S. tight oil supply growth. (See: How Would The Iran Nuclear Deal Impact Oil Prices?) We now expect crude oil prices (Brent) to average around $63 per barrel this year and increase at a decreasing rate to around $93 per barrel by 2021. Below, we outline the basics of the statistical model that we use to arrive at our forecast and the key assumptions that drive our outlook for the inputs to the model.

  • Statistical Model: We believe that at the heart of the recent volatility in crude oil prices is the sharp increase in non-OPEC supplies relative to the overall demand growth. In order to substantiate this argument, we looked at the correlation coefficient between the spread between the growth in global demand and non-OPEC supplies of liquids (crude oil and condensates, natural gas liquids, processing gains, and biofuels) with the change in annual average Brent crude oil prices between 2001 and 2014. We found the two variables to be highly correlated with a correlation coefficient of 0.72. Statistically, this implies that the spread between global demand and non-OPEC supply growth explains around 52% of the overall volatility in crude oil prices. While we agree that correlation does not imply causation, the behavior in oil prices relative to the estimated demand-supply spread does make intuitive sense. For example, as the chart below highlights, when non-OPEC supply growth exceeded the growth in liquids demand by 1.7 million barrels per day in 2009, crude oil prices fell by more than 36%. Similarly, oil prices increased sharply by almost 29% in 2010 as the growth in demand exceeded non-OPEC supply growth by 1.8 million barrels per day. We therefore use the single-variable linear function between these 2 variables to base our long-term crude oil price forecast. [1]

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Below, we discuss the key assumptions driving our long-term outlook for the supply and demand of liquids fuels, which forms the basis of our forecast for the input variable, the spread between global demand, and non-OPEC supply growth.

  • Non-OPEC Supply Growth: Global liquids supply has increased significantly over the past few years, driven by non-OPEC sources, especially the U.S., where increased horizontal drilling of relatively impervious shale rocks has led to a significant jump in production. According to the latest statistical review of world energy by BP, the country’s liquids production increased by almost 1.6 million barrels per day or 15.9% year-on-year in 2014. This made up for more than 75% of the total net growth in global liquids production last year. However, following the slump in oil prices during the second half of last year, drilling activity even in the most prolific tight oil plays in the U.S. has declined sharply, which is expected to slow down production growth from the U.S. to just around 630,000 barrels per day this year. (See: Oil Prices To Remain Capped In The Short Term, Despite Fewer Shale Oil Barrels) We still expect non-OPEC supply growth to stand at around 1 million barrels per day this year, with the rest coming mostly from Brazil and Russia. However, in 2016, we expect liquids supply from non-OPEC countries to be slightly lower (-0.2%), as the full impact of lower oil prices on the U.S. tight oil production is expected to more than offset the continued increase in production from other countries. Beyond that, we expect non-OPEC supply growth to steadily increase to around 2% or 1.2 million barrels per day by 2021, primarily driven by increased tight oil and pre-salt production in the U.S. and Brazil, respectively, as oil prices recover.
  • Global Demand Growth: While the demand for petroleum products has been consistently declining in developed economies, primarily due to vehicle fuel efficiency improvements, it has remained buoyant only because of increasing economic activity in emerging markets. According to our estimates, the BRIC nations (Brazil, Russia, India, and China) have contributed almost 84% to the net growth in global crude oil consumption between 2008 and 2014. However, over the last 3-4 years, the growth in economic activity in these countries has slowed down significantly. For example, China’s GDP, which grew at 10.4% in 2010, expanded by just 7.4% last year and the IMF expects the slowdown to persist in the medium term. Similarly, India’s economic growth has also slowed down from 10.3% in 2010 to just 7.2% last year, and it is expected to improve only marginally this year. This moderation in emerging markets’ growth, and persistent weakness in the Euro-zone, led the growth in global crude oil demand to hit a 5-year low of around 700 thousand barrels per day (MBD) last year. [2] However, demand growth has accelerated significantly this year because of the steep fall in crude oil prices over the past 12 months. We expect global liquid fuels demand to increase by around 1.4 million barrels per day, or 1.5% this year, and continue to trend higher at 0.35 times the growth in global GDP in the long run. We have assumed the growth in global GDP to increase to around 4% by 2018, from an estimated 3.5% this year, and remain relatively stable beyond that. [3]
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Notes:
  1. IEA Oil Market Report, iea.org []
  2. BP Statistical Review of World Energy 2015, bp.com []
  3. Uneven Global Recovery, Complex Underlying Currents, imf.org []