Medium term oil outlook: Merrill Lynch Part 1

Medium term macro outlook for oil

  • The share of energy consumption as a percentage of global GDP has dropped to just 3.7%, the lowest level since 2002.
  • Global spare oil production capacity remains relatively low by historical standards.
  • The current price shock is different to the last three because it is mostly driven by a massive surge in North American oil production.
  • High volatility in spot prices is likely to be sustained if OPEC no longer acts as a balancing agent of last resort.
  • Merrill Lynch now see a US$100/bbl trading range over the next five years and lower average realised prices for Brent that range between US$60 and US$90/bbl.
  • In the next 18 months, Merrill Lynch see a large global petroleum inventory buildup keeping prices relatively contained in a US$40 – 70/bbl level.
  • OECD oil stocks are expected to peak at 2.9 billion bbls.
  • A continued build in storage is likely to further exacerbate near term price volatility.
  • Merrill Lynch expects shale oil production in the US to peak sequentially over the coming months but come back in the outer years.
  • A continuation of the high price environment since 2011 may have led to zero global demand growth, or peak oil demand by 2025.
  • Merrill Lynch estimates that if oil stays at US$50 – 70/bbl over five years, peak demand will be pushed out well past 2030.
  • Merrill Lynch expects to see a large structural pick up in diesel and gasoline vehicles sales in major emerging markets (EM) in response to the lower retail prices.

Medium term oil demand outlook

  • In a US$100+/bbl world, the global oil market was heading in cruising speed towards peak oil demand.
  • Expensive oil prices would have driven consumers to switch towards smaller, more efficient cars, swap gasoline for diesel vehicles or stop driving altogether.
  • Eventually, high prices could have led to substitution out of oil, whether towards cheaper fossil fuels like natural gas or to alternatives and renewables.
  • In the absence of well formulated long term policies, efficiency and substitution trends will be weaker and global oil consumption will continue to grow for a lot longer than originally envisaged.
  • Lower oil prices, combined with a steady pick up in global GDP growth, is set to boost oil demand medium term.
  • One way lower oil prices may lead to higher oil demand is through the income effect.
  • Net importers should benefit tremendously from sharply lower import costs, helping to reduce trade deficits.
  • There is the direct impact of lower prices on oil demand, although the short term price elasticity of oil demand is rather small.
  • On a global basis, a 10% drop in prices would increase demand by 0.3%, far trailing the impact GDP changes can have on overall consumption.
  • Lower oil prices are a positive for oil demand, all else equal.
  • Several EM countries use some degree of price fixation to keep retail prices artificially low, making demand less sensitive to crude oil price changes.
  • Many market observers have pointed to the removal of subsidies as a constraining factor in oil demand growth.
  • Near term, Merrill Lynch sees a negative drag on oil demand in some EMs.
  • Approximately 50% of oil demand growth in the last decade has come from oil exporting countries.
  • Merrill Lynch economists estimate that the drop in oil prices from US$99 last year to US$55 this year shaves 1.7% off GDP growth in 2015 in GCC countries.
  • If oil prices were to stay sub US$60/bbl, the decline in OECD oil demand may be lessened by 0.5% or 250 000 bpd/y on average on a five year horizon.
  • Merrill Lynch expects average fuel efficiency to rise over the next five years, albeit less than last year, due to lower oil prices and the switch to larger vehicles.
  • The trend for oil demand in Europe is increasingly negative as the population at a driving age is outright contracting.

Edited from report by Claira Lloyd

Published on 16/02/2015

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