Energy

Julian Lee is an oil strategist for Bloomberg First Word. Previously he worked as a senior analyst at the Centre for Global Energy Studies.

This isn't the way things were supposed to be for the oil market.

Instead of seeing supply and demand rebalance and prices recover, we're sitting on the edge of a bear market.

Yet again, a glut in supply is calling the shots, and it's getting hard to see how that will change. But actually, that's just what's due to happen. Investment -- or rather, the lack of it -- is the key.

Faltering Recovery
Crude oil prices are down around 20% from this year's peaks in early June
Source: Bloomberg

2016 had such a promising start. Whether you listened to government agencies, banks, analysts, oil companies, or the oil-producing countries you would have heard the same message -- the market will begin to rebalance in the second half and inventories will start to fall as rising demand overtakes dwindling supply. Prices could then start on a sustainable recovery.

A month into the third quarter, and the price of OPEC's basket of crudes (comprising the largest export grade from each member country) fell below $40 a barrel on Thursday for the first time since April.

We are where we are because of a decision Saudi Arabia made back in November 2014 to abandon its unofficial role as the world's swing producer. The ensuing drop in oil prices was meant to allow the low-cost OPEC producers to regain control of a market that they had lost to the U.S. shale oil industry.

The promised land was a recovery in the oil price to a more acceptable level -- although what "acceptable" might look like has always been a moveable feast.

It hasn't quite worked like that. Demand has not surged as producers had hoped, and supply has proven more resilient than expected.

Crude Imbalance
The surplus of oil supply over demand should have come to an end after 10 quarters of excess
Source: IEA

Demand growth is slowing from its lofty levels earlier this year, dashing hopes that the supply will get soaked up quickly.

But the real story is the supply outlook. There's little cause for optimism here, at least in the short term. There was a ray of hope when unexpected supply disruptions over the spring and early summer of this year, most notably in Canada and Nigeria, pushed up prices. Though there's is no end in sight to Nigeria's problems, Canadian production has been all but fully restored. 

And we're still seeing additional supplies from projects that were sanctioned in an era of much higher prices -- including some from the days when oil prices were even lower than they are now. ENI expects production from the troubled Kashagan field in Kazakhstan, where a final investment decision was taken in 2004, to begin by the end of the year.

The glut persists.

For the oil market, the result is a delay in the start of a long-waited rebalancing. The pickup in prices to above $50 a barrel in June looks to have been a false dawn. The price recovery is not yet here. 

So, if not now, when? Russian oil minister Alexander Novak suggests the market may now reach balance by mid-2017. Goldman Sachs said in a July 27 report that oil prices would remain between $45 and $50 a barrel through to the middle of next year.

Collapsing Capex
Capital expenditure by the Western oil majors is expected to fall by 42% between 2013 and 2016
Source: The companies
Exxon, Shell (including BG), Chevron, Total, BP, ENI, Conoco

But change is coming: companies have slashed capital spending on new projects. This will inevitably slow the flow of new oil onto the market in the future.

U.S. production is still falling outside Alaska, despite a modest upturn in the rig count in recent weeks. Elsewhere, there has been a dearth of investment decisions to develop new production. Chevron's move to proceed with the expansion of its Tengiz field in Kazakhstan stands out because it's the biggest investment in new production capacity to be announced since the price collapsed in mid-2014.

Meanwhile, demand growth should broadly stick to the trend of the last 20 years, growing by a little over 1 million barrels a day each year. The stage is set for demand to overtake supply.

Oil prices will rise -- just not yet. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Julian Lee in London at jlee1627@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net