Oil: The Great Rebalancing

by: The Financialist

By Ashley Kindergan

On June 8, the price of Brent crude ticked above $50 a barrel for the first time since August 2015. But the new $50-plus era came to an end two days later, amid a broader selloff that affected multiple asset classes. Energy analysts with Credit Suisse's Global Markets team point out, however, that both supply (which is shrinking) and demand (which is growing steadily) point to firming oil prices ahead. Indeed, the bank's analysts think that after two years of oversupply, the crude oil market is finally showing signs of rebalancing.

The supply side of the oil equation has gotten the lion's share of recent attention. Data from the U.S. Energy Information Administration showed that crude oil inventories decreased by 933,000 barrels to 1.226 million as of June 15, the fourth weekly decline in a row. Credit Suisse's energy analysts expect total U.S. liquids production to decline by another 460,000 barrels per day in 2016 compared to 2015.

The biggest upside risk to supply was Saudi Arabia, the world's largest oil producer, but the country is now signaling that it is not interested in flooding the market with additional barrels of crude oil. The Kingdom tried and failed in early June to convince its fellow members of the Organization of Petroleum Exporting Countries to agree to a production ceiling, and has since vowed to maintain production capacity at 12.5 million barrels per day. Data about Saudi exports and rig counts further support the idea that the Kingdom is not planning a major supply boost.

Trends in both short- and long-term demand also point to a firming of oil prices. BP's recently released 2015 Statistical Review of World Energy paints a picture of long-term demand growth that is both more resilient and more widespread than is commonly appreciated, Credit Suisse's analysts said. Oil demand has been growing 1.4 percent a year on average for the last five years, and while emerging-market demand is driving overall growth, recovering developing economies have also played a significant role. And even in the face of competing renewable products, oil's share of total energy use has held steady at 30 percent in emerging markets and 33 percent in global terms over the last decade.

There has also been a marked uptick in demand over the past year. In 2015, oil consumption grew 1.8 percent, up from 1 percent in 2014. Credit Suisse's energy analysts expect that global oil demand will increase by another 1.8 percent in 2016, even after a relatively mild winter in the Northern Hemisphere reduced the need for oil heat in the early months of the year. Credit Suisse sees an especially strong case for growth in the United States, where consumers are driving more and using more gasoline as a result.

Credit Suisse estimates that global demand will start to outstrip supply this summer, but the bank's analysts note that may take up to a year to work through oil inventories, which are still very large despite the recent drops. The bank's analysts expect Brent crude oil prices to end the fourth quarter of 2016 at $43.50, after averaging $35.32 in the first quarter of 2016. Barring a recession, the bank's analysts say global oil demand will be strong enough to lift prices above the $60 threshold in 2017 - a level that would surely jumpstart further production in the United States. That's something investors in U.S. energy companies, who have had a very tough couple of years, will likely be happy to hear.

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