In OPEC's latest annual World Oil Outlook [8]released on Wednesday, the now defunct cartel (courtesy of Saudi Arabia's insistence on vetoing any production limit) said that demand for its crude will slide to 2020, as rival supplies continue to grow. On the supply side, OPEC said it would need to pump 30.7 million barrels a day by the end of the decade, which is 1.7 million barrels more than it projected a year ago but well below, or some 1 million barrels less than the group pumped in November.
As Bloomberg notes [9], this latest forecast underlines the struggle faced by OPEC as it seeks to defend market share against a surge in output from rivals such as the U.S. and Russia. As a reminder, one of the most unexpected outcomes of the recent collapse in oil prices is that while the Saudis had hoped non-OPEC production would plunge, the opposite has happened in the race to the bottom in which Russian oil production just hit a record [10] while US shale production has remained steady even as the number of oil rigs has plunged to multi-year lows.
"Although lower oil prices continue to foster some demand growth, their impact seems to be limited by other factors,” the group said. “The removal of subsidies and price controls on petroleum products in some countries and ongoing efficiency improvements will all likely continue restricting oil demand growth.”
As a result of the frail balance between declining demand and rising supply, the 30.7 million barrels of daily output needed from 12 of OPEC’s members in 2020 is about 300,000 a day less than required this year, when it repeatedly pumped above its production target before scrapping the limit altogether earlier this month.
[11]
Needless to say, OPEC forecasts are about as bad as those made by the Federal Reserve, and even so over the long run OPEC assumes that prices will rise to average $80 a barrel in nominal terms in 2020, and $70.70 in real terms. As Bloomberg reminds us, last year it had anticipated nominal prices of $110 and real levels of $95.40. That means the value of the group’s output in 2020 would be $218 billion less than estimated a year ago, when it first embarked on the policy to protect market share. That is nearly a quarter trillion gap which oil exporting countries, whose budgets are heavily reliant on oil production and prices, have to fill by other means such as selling reserves which they have been doing as part of the demise of the Petrodollar, something we previewed over a year ago.
The optimism in the latest OPEC report comes on the demand side, as the organization increases its estimate for global oil demand in 2020 by 500,000 barrels a day to 97.4 million a day. By then, fuel consumption in emerging nations will overtake that in the industrialized economies of the Organization for Economic Cooperation and Development, it said.
OPEC is also hopeful that the shale revolution will finally end, and that non-OPEC supply in 2020 will fall by 1 million barrels a day to 60.2 million a day as “market instability” leads to reductions in spending and drilling. Still, non-OPEC supply will still grow by 2.8 million barrels a day this decade, including 800,000 barrels of additional U.S. shale oil. OPEC said the outlook, which incorporated some data set in the middle of the year, was “clouded by uncertainties.”
And while OPEC, tired of being very wrong in its near-term forecasts laid out forecasts going through 2040 which have absolutely zero chance of being even remotely accurate, it is notable that according to Bloomberg almost $10 trillion will need to be invested in the oil industry through to 2040 to develop the required supplies, with $7.2 trillion of this in exploration and production. Producers outside OPEC will need to do the bulk of the spending, investing $250 billion a year. Where this CapEx will come from in an age when producers are slashing exploration and production outlays is not exactly clear.
* * *
Perhaps it is as a result of "cloudied uncertainty" and ongoing race to the bottom by all oil producers, OPEC and non-OPEC alike, that someone is betting that OPEC will be woefully wrong in its price forecasts, and is buying puts that see oil plunging as low as $15 a barrel next year, the latest sign some investors expect an even deeper slump in energy prices. The bearish wagers come as OPEC’s effective scrapping of output limits, Iran’s anticipated return to the market and the resilience of production from countries such as Russia raise the prospect of a prolonged global oil glut.
This ties in with the recent forecast by Goldman Sachs which has said $20 oil is not impossible: "We view the oversupply as continuing well into next year," Jeffrey Currie, head of commodities research at Goldman Sachs Group Inc., wrote in a note on Tuesday, adding there’s a risk oil prices would fall to $20 a barrel to force production shutdowns if mild weather continues to damp demand.
As the chart below shows, the bearish outlook on oil prices has prompted investors to buy put options at strike prices of $30, $25, $20 and even $15 a barrel, according to data from the New York Mercantile Exchange and the U.S. Depository Trust & Clearing Corp. With WTI currently trading at about $36 a barrel, this means someone is wagering on a drop which could be greater than 50% in the coming months.
[12]
As Bloomberg points out, [13]investors have bought increasing volumes of put options that will pay out if the price of WTI drops to $20 to $30 a barrel next year. The largest open interest across options contracts - both bullish and bearish - for December 2016 is for puts at $30 a barrel.
The number of outstanding contracts below $30 a barrel is relatively small. But the open interest for June 2016 put options at $25 a barrel has nearly doubled over the last week. Investors have even bought put options that will pay if WTI drops below $15 a barrel by December next year. The volume of financial bets at that level is tiny - 640,000 barrels in total.
While the position may be simply a hedge instead of a direction bet, it reveals that the prevailing mood is hardly one of OPEC-ian exuberance. “Overall it’s still very bearish,” Gareth Lewis-Davies, a London-based energy strategist at BNP Paribas SA, said.
Of course, for every put buyer there is a put seller: it remains to be seen who will end up right, although as Victor Shum, a vice president IHS Inc., says in Bloomberg Television interview said "with WTI now pretty much at parity with Brent and Brent being the global oil benchmark, that really indicates a massive oversupply situation in the world."
Finally, since oil has become a key coincident signal for the entire market, should oil indeed plunge another 50% from here, all those bullish "strategist" forecasts for a low double digit in the S&P will promptly have to be scrubbed, again, should the black gold resume its downward trajectory from this latest dead cat bounce.
