The bear market case for oil

Welcome to another Energy Source.

Oil remains the big story in energy markets, with prices down sharply again yesterday. In our first note, I talk with Ed Morse, Citigroup’s global head of commodity research and the doyen of oil market analysts. He shares his view on why the crude price is still defying Saudi Arabia, which announced new cuts just over a week ago — but has watched prices continue to drift lower.

In our second item, Aime reports on a proposal to avert more carbon trade rivalry. In Data Drill, Amanda picks up a report on fossil fuel producers’ flaky net zero commitments.

Thanks for reading. Derek

PS Join us on June 15 for the FT’s Hydrogen Summit, where energy CEOs, senior policymakers and financiers will discuss the opportunities and obstacles in harnessing the full power of hydrogen. FT Premium subscribers can register for free here.

The view from the bears’ perspective

Saudi Arabia is cutting oil output and analysts from the International Energy Agency to Wall Street think a roaring Chinese economy will put rockets under demand later this year, while supply growth remains tepid.

So why are oil prices continuing to drift lower? We asked Ed Morse, Citi’s veteran head of commodity research and a bearish voice in a thicket of market bulls.

Morse’s argument: there is still plenty of supply out there; and the bullish faith of market cheerleaders is misplaced. “Our basic judgment is that supply is going to outstrip demand in the second half of the year,” he told ES.

Prices will not average much more than $82 a barrel this year, he predicts — a good 20 per cent beneath some forecasts. Next year, they will be “well below” that level. This is his case:

1. China is not going to ride to the rescue

There has been a longstanding belief that China’s energy-thirsty economy is going to finally crank back into gear later this year to bolster global crude demand and push prices higher.

Not so, says Morse. 

“They [oil bulls] have a notion — that is reinforced by both the IEA and the Opec Secretariat — that demand is going to really loom large in the second half of the year,” he told ES. “They are super bullish on China finding a way to stimulate the economy in ways that the government has opted not to do so far.”

But in reality, Chinese diesel demand has long since peaked, he says. And its gasoline demand will be close to peaking by the middle of the decade. 

“We think that a consensus in the market about China having multiple years of high demand growth is really a misunderstanding of where the drivers of demand have been in the country . . . ”

2. GDP growth is decoupling from oil demand

Economic growth no longer carries the same punch for the oil market.

Before the pandemic, gross domestic product growth of 1 per cent a year implied about half a per cent growth in oil demand, Morse said. But that elasticity has fallen — and the fall is about to get sharper. 

“We think people are underestimating the structural phenomena that are at work,” he said. “They certainly bring down the relationship between GDP growth and oil demand.”

By the middle of the decade, a peak in motor vehicle demand in the US and Europe, coupled with a peak in Chinese diesel consumption and a nearing peak in its gasoline consumption, means even a fast-growing economy will not be enough to set a fire under oil demand.

That’s a deeply bearish underlying notion for the oil market.

“If you get 4 per cent GDP growth around the world, what is demand growth likely to be? You can be hopeful if you’re on the environmentalist side and think it’s going to be zero. Or I think you can be more realistic and say it’s going to be less than 1%. And it may even be half a per cent,” said Morse.

​And if demand is only to grow by 0.5 per cent, that is just 500,000 barrels a day. Can the world find that much extra oil? “It’s not hard,” said Morse.

​The US alone will probably account for that much extra supply.

3. ‘There’s a lot of oil around’ 

In fact, looking at growth in oil producing hubs around the world, supplying that growth looks pretty easy.

“If world demand is not increasing at 2mn barrels a day, and you add up what’s happening in the US and Brazil and Guyana and Australia and Argentina and Norway and Canada and even Venezuelan numbers . . . there’s a lot of oil around.”

Oil output is rising again in each of those countries. Yes, even Venezuela, which Platts believes is now producing almost 800,000 b/d.

Arguments that a lack of investment — in the US shale patch and beyond — will curtail supply in the coming years are overstated, he said. “As far as we can tell, the argument that costs are going up and spending is going down is wrong, because it misses the greater efficiency of capital use.”

Big shale drillers, including ExxonMobil and Chevron, are able to produce roughly double what they did in 2019 for the same price, Morse said. 

“​We’ve seen it time and time again, we saw it certainly between 2014 and 2016, when capital spending did go down but productivity went up — way up, as companies found ways to produce more with less.”

5. What is Opec going to do?

The big wild card then, is Opec. Is the cartel willing to make further cuts to support the market?

Beyond Saudi Arabia, there does not seem to be much appetite. And the group’s repeated efforts to intervene in the market of late have done little to support prices.

“I am sceptical about an organisation that has changed production outlook three times since October saying: ‘Hey, this is permanent,’” said Morse.

That Opec will keep its latest production plans intact to the end of 2024 seems unlikely. “I certainly don’t think it’s permanent for Iraq, and their plans. And it’s definitely not for the UAE.”

Indeed, with Brent down more than $4 a barrel since Saudi Arabia’s announcement of a further temporary 1mn b/d cut last week, the group’s ability to prop up the oil price against the tide of macro dynamics seems increasingly limited. (Derek Brower and Myles McCormick)

A new proposal to simmer green trade tensions

Joe Biden has largely put a stop to the fractious trade wars of the Donald Trump era, soothing allies by suspending tariffs and offering fresh talks on a long-running dispute on aircraft subsidies.

But the president has brought along with him a new era of green trade friction, angering America’s allies with a generous subsidy package available to companies making cars, batteries and other clean tech bits in the US.

A disagreement between the US and EU over how to account for carbon in traded goods is about to intensify. This year, the EU introduced the world’s first carbon border tax. The levy, which is applied to imports in particular sectors, is linked to the carbon price set by the EU and paid by its domestic producers.

In a new paper, former White House climate adviser Paul Bledsoe and former trade official Edward Gresser suggest a neat solution: Europe could be cut in on some of the Inflation Reduction Act’s subsidies in exchange for rethinking its carbon border tax.

The deal could apply more broadly than just to Europe, the authors say. Across the G7, countries could agree to measure the emissions intensity of products in sectors including steel, aluminium, fertiliser, hydrogen, cement and electricity. Any traded goods with embedded emissions above the agreed threshold could be taxed.

In exchange, traded goods from G7 countries agreeing to the terms could be eligible for some of the subsidies under the IRA, including but not limited to tax credits for minerals, batteries and car parts. 

The G7 has been considering the details of a “climate club” on trade since late last year, but has so far released few details. Alongside this, the US and EU are engaged in slow-moving talks on a climate-related deal for steel and aluminium. But very little has been accomplished.

Bledsoe said it was still unclear how the proposal to pull back on the carbon border tax in exchange for a slice of the green credits would go down in Brussels. But he added: “There is no reason to restrict our trade — there is every reason to trust our allies to provide secure supply lines to important energy resources.” (Aime Williams)

Data Drill

Net zero commitments from fossil fuel producers are “largely meaningless”, says a new report by Net Zero Tracker, a research consortium that includes Oxford university and the University of North Carolina at Chapel Hill. 

Two-thirds of the world’s largest fossil fuel companies have made net zero commitments, up from 45 per cent last year, according to the report. But most do not include or clarify coverage of Scope 3 emissions — those generated from end products — which make up the bulk of the industry’s carbon footprint. No companies have made commitments to phase out oil and gas production by mid-century, defying UN guidelines saying credible net zero pledges must have “specific targets aimed at ending of and/or support for fossil fuels”. (Amanda Chu)

Power Points

Energy Source is written and edited by Derek Brower, Myles McCormick, Amanda Chu and Emily Goldberg. Reach us at [email protected] and follow us on Twitter at @FTEnergy. Catch up on past editions of the newsletter here.