Posted on May 20, 2018

Oil prices reached new highs for the year last week, peaking at USD79/barrel with the last leg up given mainly by the news that the US is withdrawing from the international nuclear deal with Iran.

As a result of the recent strength in oil prices, we are revising up our forecasts for average annual oil prices to USD69/barrel for 2018 from USD63/b, and to USD66/b for 2019 from USD61/b. We expect oil prices to retreat from their current highs later this year as the impact on Iranian oil exports from new US sanctions is likely to be mitigated by increased exports elsewhere and by weakening demand growth.

So far during 2018 oil prices have risen around 18%, averaging USD69/b. A number of factors have pushed oil prices up more than expected this year. On the supply side, compliance with the OPEC-led agreement to cut production has been impressively strong at 163% within OPEC itself and at 90% among the non-OPEC parties to the agreement. The supply outlook has been further depressed by a deteriorating political and economic situation in Venezuela and the re-imposition of US sanctions on Iran. Finally, infrastructure bottlenecks in US shale oil fields have constrained the near-term outlook for US supply growth. On the demand side, the outlook has remained strong. A colder than normal winter has helped to erode inventories in OECD countries down close to the five-year average. Additionally, global growth forecasts were revised up early in the year.

Although, in the short term, oil prices may be pushed higher by Iranian sanctions, later in the year we expect prices to begin to ease. First, the impact of the US re-imposing sanctions is likely to lead to lower Iranian crude oil exports, but Saudi Arabia has announced that it will act in co-ordination with other countries to mitigate the effects of any supply shortages. Second, producers are likely to respond to higher prices by ramping up output with US shale production continuing to increase despite the bottlenecks. Third, demand growth is likely to weaken as we expect global growth to slow (see our previous commentary, IMF forecast of accelerating global growth is optimistic) and high prices are likely to incentivise energy efficiency.

We expect prices to ease further in 2019. The bottlenecks facing US shale production are likely to ease as new pipelines should be completed around the middle of next year. The shale breakeven oil price is still estimated to be in a range from USD60/b to USD65/b and supply is, therefore, likely to continue to be ramped up as long as prices remain above this level. The OPEC-led agreement expires at the end of this year, which could lead to higher production, especially considering that inventories are close to OPEC’s five-year average target. Finally, we expect slower oil demand growth as the global economy slows further and as high prices continue to erode consumption growth.

In conclusion, with the prevailing high oil prices supply growth is likely to outstrip demand growth in both 2018 and 2019. This is likely to bring the market from being undersupplied in 2017 to balanced in 2018 and oversupplied in 2019. We forecast oil prices based on a model that accounts for supply and demand fundamentals, futures prices and consensus oil price forecasts (see our previous commentary, Oil prices to average USD60-65/b in 2018 on balanced market). Based on this model, we now expect prices to average USD69/b in 2018 and USD66/b in 2019.