In 2019, I entered my fourth year as a writer on Seeking Alpha. Through all this time, with more than 550 articles written, my most widely read article continues to be an early 2016 article predicting the OPEC oil production cut before it happened. I plan to make this a tradition, and as a result, this article will describe my 2019 oil market outlook.
Last Year's Oil Markets
To begin with, let’s see what happened in the oil markets last year. The ending of 2018 introduced some interesting dynamics that will increasingly come into play in 2019.
As we can see from the above chart which shows WTI Crude oil prices, from the start of the year up until when the market peaked in early-October, crude prices - with the exception of some volatility - increased significantly. WTI crude oil prices peaked at more than $75 per barrel, and Brent prices increased to more than $80 per barrel. For a while, it looked like the oil crash was over and prices were recovering.
Then, worries of global demand set in. That, combined with American decisions in Iran, impacted oil prices. The United States decided to restart sanctions on Iran, and as a result, it was anticipated that Iran's production would drop significantly. As a result, the United States asked Saudi Arabia to turn on the spigots, increasing production in anticipation of an Iranian production drop.
However, then waivers were granted to countries that wanted to keep importing oil from Iran. This led to the country keeping production higher than anticipated, which, like all commodities, led to a significant drop in prices. Even with the new year recovery, oil prices are still almost 40% below where they were just a few months ago. This is the market where we are entering 2019 with.
Now that we’ve discussed last year's oil markets, let’s continue by discussing the current predictions of others.
The above graph shows the IEA predictions for the demand and supply balance in 2019. There is anticipated to be a strong oversupply in oil in 2019, mainly due to anticipated current production from Iran and a potential global slowdown. For reference, this significant oversupply is on the magnitude of the one that led to the 2014 oil crash, the longest in recent history.
Current oil prices are roughly $50 per barrel WTI, and a continued oversupply could have an enormous impact on that. In fact, should the oversupply match IEA predictions for 2019, I wouldn’t be surprised to see oil prices go down and test their early 2016 lows of less than $30 per barrel. Given at current oil prices, where stock prices have dropped significantly already, this could cause a meltdown in energy stocks.
This next graph shows Goldman Sachs' current price forecast for 2019, last updated yesterday. The company originally saw Brent prices in the $70 range, compared to current prices of over $58 per barrel. However, it has since updated its guidance to roughly $62.5 per barrel. That represents a 10% drop in the company’s forecast, which is a fairly big hit.
Goldman Sachs updated its guidance in the face of what it believes to be a long-term oversupply. Still, even the company seems to believe that oil prices will finish the year 5-10% above current prices.
Now that we’ve discussed current predictions, I’m going to continue with my opinion on the oil markets in 2019.
I believe that 2019 oil markets will rely on the decisions of the members of OPEC. The organization regularly makes multi-million barrel production cuts during crises, as it did in 2009. The group carried out another production drop in early 2016, however, due to countries like Iran trying to maximize production before sanctions, it didn’t really work. Still, recent production has dropped.
Saudi Arabia feels duped by the fact that Iran’s production didn’t drop due to waivers. As a result, oil prices dropped significantly, and so did Saudi Arabia’s earnings. I believe that the country will be eager to fix this going into 2019 with the potential for a 1+ million barrel per day production cut.
OPEC and Russia agreed to a 1.2 million barrel per day production cut in December 2018 that would last for a period of 6 months starting in early 2019. I definitely expect this to be extended, if not expanded. Keep in mind that Russia is now a part of this OPEC group, where it wasn’t originally, which means there is potential for a significant increase in production cuts.
As much as the oil production environment has changed, Russia + OPEC still control 40+% of the global supply. Them cutting production by 2 million barrels per day would require U.S. production growth on the order of double-digits percentage-wise, something that I see as unlikely even with the U.S.'s growing role in the oil markets. Personally, I believe this could lead oil prices to recover quicker than currently anticipated.
The above map shows rig and permit counts as of the end of November. While the data is a bit older, it can be seen that the rig count is dropping. The drop in oil prices means that shale producers are focusing less on exploration. In an oil market that’s harder to predict, shale producers are going to have less incentive to continue the vibrant expansion seen in 2014.
I think that the late 2018 oil crash will do a lot towards cementing this slowdown in production growth. Producers who expanded their rig count in 2017 and 2018 thinking the worst was over were impacted hard. Fooled once, even twice, these producers will be much more careful about being impacted a third time.
This is especially important because of the effect that U.S. oil production has had on the markets recently. Increasing American oil production meant an oversupply in the market, while also hurting OPEC’s ability to control the markets. However, less consistent oil prices would decrease shale production. That could help OPEC’s control and oil prices.
As a result of these developments, I see Brent prices averaging higher for 2019 than others are estimating. For the first half of the year, I see prices averaging in the low $60s per barrel, increasing to $70 per barrel Brent average for the second half of the year. I think higher prices will be driven by Saudi Arabia and OPEC cutting production, combined with a tapering off in production from shale.
At the same time, I think that if prices drop significantly, the oil majors would all be good investments. The Vanguard Energy ETF (VDE) is back to where it was in early 2016, when prices were 40+% lower. As a result, investing in the ETF is also a decent investment. For those looking for more detail about how to invest in crude, I recommend looking at the Big Oil Portfolio.
Let me know what you guys think below.
Disclosure: I am/we are long VDE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.