Weak Fundamentals Suggest Oil Prices Will Remain Low
Oxford Analytica thinks oil prices are likely to remain low, even if economic growth picks up later this year.
Producers argue that oil prices need to remain high to fund the investment necessary to meet future oil demand, an important part of which is replacing production lost to depletion, OxAn says in Outlook for oil prices looks weak. They say that at current price levels investment will be insufficient. Once oil demand growth resumes, OPEC’s production cuts will be quickly eroded as will the level of surplus capacity. The attraction of this argument is that it justifies high oil prices no matter how bad or deep the current crisis because it is future shortages that are the imperative rather than the present.
“However, with supply relatively abundant and OPEC finding each incremental reduction towards its output goal of 24.845 million b/d harder, how demand evolves is critical to the price outlook. It is far from certain that a return to the pre-credit crisis ‘peak oil’ paradigm of ever-rising commodity prices will be quick, or will happen at all.”
- Consumer wealth. Part of the ability to absorb rising oil prices without impacting demand was that oil had become relatively cheaper in terms of the proportion of consumers’ disposable income that it absorbed.
However, with rising unemployment, economic contraction and falling wage inflation, oil continues to be perceived as expensive, despite having lost two-thirds of its value since its peak.
- Substitution effects. Although oil demand is characteristically inelastic, substitution effects do occur and their impact, rather than being reversed as prices fall, may be compounded by an increase in legislation designed to reduce greenhouse gas emissions and to improve countries’ security of energy supply.
“While many forecasters argue that the majority of substitution effects are reversible rather than structural, the continuing impact of current energy policies might also be seen as gathering momentum. There is a tendency to assume that under ‘normal’ economic conditions, oil demand will always rise everywhere, and for developing economies it will trend towards per capita levels seen in the OECD. However, both Japanese and European oil demand was falling or static before the financial crisis, while neither have nor are likely to see the same level of car ownership as the United States.”
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