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Can the market sustain USD100 oil?

With oil prices hovering around USD80 per barrel, industry analyst McKinsey suggests that a combination of factors could tighten oil markets further and propel the commodity past USD100.

McKinsey’s Pawel Wilczynski and Evelina Pagkalou said that a lack of spare production capacity among the Organization of Petroleum Exporting Countries (OPEC) members, plus infrastructure constraints in the USA, could reduce the industry's ability to respond immediately to supply and demand disruption.

However, the long-term sustainability of USD100 per barrel oil was called into question as infrastructure bottlenecks are expected to subside and the outlook for the global economy worsens.

According to McKinsey, in the short term, Iran poses the largest risk to crude supply. Purchases of Iranian crude by Asian countries and European companies have already slowed considerably. According to Bloomberg, Iranian crude exports are down by 1 mn barrels per day (bpd) compared to April 2018 – the lowest levels since March 2016.

Venezuelan crude production is expected to decline by another 300-500 thousand barrels per day (kbd) as the country’s socioeconomic crisis continues. Internal strife between key political factions in Libya have the potential to remove 300-700 kbd in production and exports.

The oil industry’s ability to respond to these disruptions is questionable.

Currently, Saudi Arabia’s spare capacity is estimated at less than 2 mn bpd, potentially insufficient to cover the supply gap should multiple acute disruptions occur simultaneously. US shale oil output is typically very responsive to increases in oil prices, but pipeline and services constraints – particularly in the Permian Basin – are likely to limit the ability of shale operators to respond quickly enough to high prices.

However, post-2020, the picture starts to look quite different. Saudi Arabia has already announced a USD20 bn investment in maintenance and possible expansion of its spare capacity over the next few years. It also intends to bring two fields online with over 500 kbd output later this year.

In the Permian, four new pipelines will be gradually added after 2019 which should debottleneck the basin.

Planned pipeline capacity expansions include Sunrise, Cactus II, EPIC Crude, and Grey Oak. Any potential downturn in the global economy is likely to put downward pressure on oil demand, as witnessed in 2008-2009.

The increasing prominence of electric vehicles will likely reduce demand for  petroleum and diesel.

“When all these factors are combined, it seems unlikely oil prices can stay at above USD100 per barrel for a sustained run. While the oil markets have always been sensitive to shocks and should continue to be so, there do not seem to be any fundamentally structural changes pointing to a return to expensive oil,” said Wilczynski and Pagkalou.

This article is taken from the Capital Projects and Contracts newsletter.

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