Powering the Future

Oil prices likely to continue to struggle in the fourth quarter as demand lags

Key Points
  • Oil prices are expected to rise just a few dollars per barrel in the fourth quarter, and OPEC and its partners may have no alternative but to extend deep production cuts to support the market.
  • The fall off in air travel and a warm winter may keep pressure on distillate fuels, an important source of oil demand.
  • "The oil market is taking Covid the hardest of all of the asset classes out there," said one analyst.
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Oil prices are expected to rise just slightly in the final quarter of the year, held back from further gains by a deep chill in global travel and a still healing economy.

Analysts forecast the prices of Brent and West Texas Intermediate should rise to the low to mid-$40s per barrel, but they also see risks tilted toward another drop in oil prices.

"If anything, they're vulnerable to falling into the low $30s. The oil market is taking Covid the hardest of all of the asset classes out there," said John Kilduff, partner with Again Capital. "Demand is just not coming back, especially for jet fuel."

Oil prices have clawed back from a crushing decline earlier this year, as the global economy shut down. Oil futures prices were even temporarily negative, as the market reacted to huge oversupply and a big drop in global demand. WTI futures fell below $40 this week and settled at $38.71 Thursday, falling 3.9% amid worries about the coronavirus and reports of a rise in OPEC output.

"It looks really bleak right now. This was a bust for the ages," said Kilduff. "The demand just isn't picking up."

Bank of America expects oil prices to remain range bound in the mid $40s to year end. "In terms of downside risks, a big second Covid-19 wave was always going to rank first, but a warm winter now ranks second given the persistent surplus in distillate fuels," according to Francisco Blanch, managing director of commodities and derivatives at Bank of America Merrill Lynch Global Research.

Blanch expects little price movement even though he expects the oil market could move into a 4.9 million barrel a day deficit, due to OPEC cuts if demand does rise. "Yet diesel and jet fuel/kerosene make up by far the largest petroleum product group in the oil market," notes Blanch. He said that means crude oil prices cannot gain real traction until distillate demand, including jet fuel, recovers to a more normal level.

The oil industry has been cutting back on production and spending on further development. Royal Dutch Shell, for instance, is looking to slash up to 40% of the cost of producing oil and gas in an effort to preserve cash so it can overhaul its operations and focus more on renewables and power, according to Reuters.

The industry is also debating how much of the Covid-related cutbacks could be permanent.

A recent report from BP supported a longer-term view that fossil fuel demand may have already hit its limit and may not be likely to fully recover from the impact of the virus. The Organization of Petroleum Exporting Countries (OPEC) recently cut back its near-term demand outlook, and now expects demand to average 90.2 million barrels a day in 2020, down 400,000 barrels a day from its last forecast and a decrease of 9.5 million barrels a day from a year ago.

"There are still these serious headwinds for oil in terms of the macro outlook," said Helima Croft, managing director and head of global commodities strategy at RBC Capital Markets. "OPEC is very focused on compliance. It's just a question to me of how much more can you get out of these producers in terms of compliance." 

But news reports this week that OPEC output has risen slightly is raising a red flag. Libya production is now returning to the market, at a time when OPEC has committed to cutting back.

Croft said the agreement to cut back on production by OPEC and other producers, like Russia, will be reviewed again in December. The OPEC+ group is currently holding 7.7 million barrels off the market, but in December they are expected to return some oil to the market and hold back just 5.6 million barrels, she said.

"Looking at the concerns about a second [virus] wave, and I think about some of these OPEC issues, I think there are some downside risks," said Croft. "I think the question is can OPEC be nimble in response to a changing outlook ... It's a difficult decision but they shouldn't put 2 million barrels on the market."

Citigroup analysts said OPEC members would be hurt by another dip into the $30s or even lower, and will be looking to defend the price above that level. The analysts said they expect OPEC+ to keep a floor under prices.

"Unless there's a deep recession, we expect their mutual vulnerabilities will continue to provide the gel they need to largely keep their supply discipline intact," said Citigroup strategists. "What's more, the longer they wait, the more likely medium-term supply will flounder due to reduced capital spending."

Blanch said OPEC will have to delay the return of more oil this year, unless demand picks up into the high 90 million barrels a day, not now expected by OPEC.

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"If it's a cold winter, maybe they get saved by the cold winter. If [virus] cases are not skyrocketing everywhere, they're in better shape," said Blanch. He noted one bright spot for the oil industry is that there has been no decline in petrochemical demand.

The U.S. industry has dramatically cut back production, from a high of 13.1 million barrels to 10.7 million a day earlier in mid-September. Demand for gasoline remains much weaker than normal at about 8.5 million barrels a day, down from 9.35 million barrels a year ago. U.S. drivers are an important factor in the global oil market, as U.S. gasoline sales normally account for about 10% of world oil demand.

"The economics are still not great for the U.S. but I think one of the big question marks is: 'If the U.S. started to come back would the Russians just say we're not going to do this anymore?' Constrained output is helpful in keeping the Russians on board with OPEC+," said Croft.

Blanch said another factor for oil prices is the Libyan oil is expected to come back on line. "If they're back at full throttle, they'll be back at one million barrels a day. That's an extra million barrels they don't need," Blanch said.

That could also pressure OPEC+ when it looks to return oil to the market. "If demand doesn't go into the high 90s [million barrels a day], OPEC is going to have some problems and they'll have to extend the cuts,"  he said.