Brent oil prices should trade between a relatively narrow range of $50 to $70 per barrel through 2024, with prices “anchored” around $60, according to a new report from Bank of America Merrill Lynch.
This dovetails with the current futures prices five years out, centered around $60 per barrel. Prices will bounce around, but should remain within that $20-per-barrel range.
But, of course, there are plenty of caveats with this outlook. A year ago the bank said that the risks to the forecast were skewed to the upside. Now, it believes that the downside risks are growing. U.S. shale supply continues to rise, expanding faster and by larger volumes over the past year than anticipated. Also, demand is slowing and expected to continue to decelerate.
In the short run, BofAML sees Brent rising back to $70 per barrel. The combination of OPEC+ cuts, involuntary outages in Venezuela and Iran, declines in Mexico and elsewhere, will all contribute to tighter supply. And unlike in 2017, the OPEC+ reductions this time around are occurring against tighter backdrop of lower inventories and a smaller production surplus, which should make the output curtailments more effective.
However, the flip side of the OPEC+ production cuts is that OPEC is building back up spare capacity. The phase in of the supply curbs at the start of this year translated into a jump in spare capacity from 1.1 mb/d to 2.5 mb/d “in a matter of weeks,” Bank of America Merrill Lynch stated. Throttling back on production simply means there is more supply sitting on the sidelines, ready to go in the event of an outage.
As a result, the supply risks to the market are diminished, which tends to reduce volatility and lower futures prices. “The growing spare capacity volumes should keep long-dated prices anchored in a $55 to $65/bbl range even if prompt Brent crude oil prices rebound above $70/bbl over the course of 2019 as we currently project,” Bank of America Merrill Lynch wrote.
However, one enormous source of uncertainty is the trajectory of the global economy. Manufacturing activity has dipped in multiple places around the world, particularly in China. “China has seen the most significant drop in activity when looking at the PMIs,” BofAML analysts wrote. “And of course, China has remained the pillar of global demand for most commodities in the past two decades.” Also, China just reported another month of poor auto sales, adding to the evidence of a slowdown.
The potential for a “hard landing” in China is the largest downside risk to Bank of America’s medium-term oil market forecast.
At the same time, it isn’t just the prospect of a global slowdown that threatens oil demand. Energy efficiency, renewable energy, electric vehicles and natural gas take on a larger share of the total energy mix. Bank of America sees oil demand hitting a peak in 2030, but as soon as the mid-2020s, demand growth will fall by half compared to this year’s growth rate.
However, there are a few more reasons why Bank of America believes oil prices will trade within a relatively narrow range. OPEC has shown a willingness to cede market share as U.S. shale output continues to expand. That keeps prices from gyrating too much. Meanwhile, last year President Trump and the U.S. government put pressure on Saudi Arabia to take action to keep prices in check whenever they rose too much. Political pressure could limit the upside to crude prices.
More importantly, however, Bank of America argues that supply is ultimately more elastic than previously thought. Over the past year, the more prices rose, the faster U.S. shale grew. American shale companies are still struggling to report profits, but recent history has demonstrated that the flood of Wall Street finance has increased anytime oil prices have climbed. Ultimately, when looking out over a few years, this leads Bank of America to conclude that prices will remain in check.
This echoes the “shale band” theory that emerged a few years ago. Price increases are met with faster U.S. shale supply, which drags prices back down. Conversely, any plunge in oil prices knocks shale offline, which firms up the market again. The responsiveness of shale keeps prices within a narrower band than has historically been the case. Prior to the shale revolution, the oil market overshot to the upside and downside to a much greater degree, owing to the inelasticity of conventional supply. Many analysts believe that is no longer the case because of shale.
In short, Bank of America sees oil prices rising to $70 per barrel in the short run, but trading within a $50 to $70 range through the mid-2020s.