IEA cries wolf again: the point of no return

The agency may be overestimating demand and lowballing Opec supply to foresee a tighter market than will materialise

The IEA suggests in Oil 2021, its latest medium-term outlook, that there may be no return to normal for the world oil market in the post-Covid era. But it then appears to contradict its thesis in its own demand projections.

Global oil demand is, admittedly, rebounding after an unprecedented collapse in 2020. But rapid changes in behaviour caused by the pandemic, including new working-from-home models and cuts to business and leisure travel—as well as accelerated commitments by governments towards decarbonising their economies—“have caused a dramatic downward shift in expectations for oil demand over the next six years”, while possibly pushing forward the timeline for peak oil demand.

This, in turn, is forcing “hard decisions” on oil-producing countries and companies, which on the one hand do not want to be left with stranded oil resources in the longer term but also do not want to invest in new production capacity that may have increased life-of-asset risk. The IEA warns the latter concern is leading to a lack of investment that could cause yet another supply crunch further along the line, as currently vast amounts of spare Opec crude oil capacity is run down.

“The IEA’s core mandate has always been energy security,” Fatih Birol, the agency’s executive director, stressed back in 2019. But this primacy has led some commentators to suggest the agency’s research has an inherent bias towards spotting potential supply shortages, leading it to incorrectly forecast such crunches on previous occasions.

Is this another false alarm? Comparing the oil market fundamentals in the agency’s medium-term oil outlooks pre- and post-Covid offers some clues. Is the evolution of supply and demand predictions in Oil 2021 compared with 2019’s Oil Market Report (OMR) consistent with the IEA’s overarching story of a new normal?

Demand

In Oil 2021, the IEA says global oil demand “is unlikely to catch up with its pre-Covid trajectory”, and its demand outlook supports this assertion. But where things get less consistent is in terms of oil consumption growth, even after global demand rebounds back to 2019 levels in 2022—which might suggest the agency’s demand outlook is too high. Global oil demand is forecast at 102.3mn bl/d in 2024, 4.1mn bl/d less than OMR 2019—2024 is the final year of that outlook—and 104.1mn bl/d in 2026.

But annual global demand growth in the post-rebound period in Oil 2021, from 2023-26, is virtually the same as growth over OMR 2019’s six-year projection period—1.18mn bl/d versus 1.19mn bl/d, respectively (see Fig. 1)—despite much changing for the worse on the geopolitical and economic fronts over the past two years, and for the positive on commitments to quickening the pace of decarbonisation.

The key driver for the buoyancy of oil demand growth predictions over the 2023-26 period is relatively strong economic growth, an average of 3.5pc/yr, just 0.1 percentage points less than the IEA’s pre-Covid outlook. This is despite economic globalisation and free trade being threatened under the ‘New Cold War’—with early signs relations between China and the US may worsen, rather than improve, under the Biden administration—while governments and businesses around the world have taken on massive debt to combat the economic fallout from the coronavirus pandemic.

At the same time, and more surprisingly, the annual improvement in global oil intensity over the 2022-26 period is forecast at only 2.3pc, 0.1 percentage points less than across OMR 2019’s projection period, despite a wide range of policies being adopted by major countries over the past two years to improve energy efficiency and promote electric vehicles.

Non-Opec and Opec

The IEA’s forecast for non-Opec oil production, including previously transcendent US shale output, over the 2020-26 period in Oil 2021 appears more easily defensible. Non-Opec production is seen at 61.9mn bl/d in 2024, 1.2mn bl/d less than OMR 2019, before slipping slightly to 61.8mn bl/d in 2026.

The Covid-induced demand shock—aided, albeit only slightly, by a pivot by some oil companies towards greater investment in clean energy—led global upstream oil and gas capex to collapse to c.$325bn last year—the lowest since 2006—with expectations of only a modest recovery this year, after ranging from $425-475bn over 2016-19. Spending cuts were seen globally, but with more than half of the cutbacks in the US oil patch.

As a result, the IEA is forecasting non-Opec oil production to increase by an average of 580,000bl/d pa over the six-year projection period in Oil 2021, less than two-thirds as much as in OMR 2019, with only a small increase in 2025 and small decline in 2026 as the development pipeline runs dry due to a lack of investment in 2020 and 2021 (see Fig. 2).

But the recent collapse in upstream capital spending should have far less impact on Opec crude oil capacity, given the relatively shorter timelines and lower cost for bringing projects online in many of its resource-rich countries.

In addition, several low-cost Opec members appear increasingly concerned more about being stuck with stranded oil resource in the future than investing in additional capacity that may have a constrained lifespan, and thus less skewered by the IEA’s assumed dichotomy. Despite presently being the leading price hawk in Opec+, Saudi Arabia has still made clear it intends to be the last producer even as the Oil Age goes from its peak into decline. Lower-cost Opec producers such as the Kingdom need only to undercut higher-cost competitors to guarantee custom for any added capacity.

So, it should be no great surprise that, over the past two years, several Mid-East Gulf producers, as well as Libya, have announced plans to expand production capacity by almost 5mn bl/d, with various target dates over the next two decades, putting into doubt the IEA’s conservative outlook for Opec crude oil capacity in Oil 2021 (see Fig. 3). The agency is forecasting it to increase by just 1mn bl/d, to 35mn bl/d, between 2020 and 2026.

Spare capacity

The call on Opec crude plus stock change is lower every year through to 2024 in the IEA’s Oil 2021 than in OMR 2019 (see Fig. 4), and substantially so in 2020 due to the Covid-induced collapse in global oil demand. Consequently, spare Opec crude capacity is also seen higher every year through to 2024, and remains at 4.2mn bl/d in 2026 (see Fig. 5).

“The global market still looks adequately supplied through much of the medium term” is a relatively logical IEA conclusion, but the agency still sounds a note of caution. “In the absence of fresh upstream investments, the spare capacity cushion will slowly erode. By 2026, global effective spare production capacity (excluding Iran) could fall to 2.4mn bl/d, its lowest level since 2016.”

This IEA assessment is, though, based on what could prove, as argued above, an overestimate of global oil demand and, possibly, a significant underestimate of Opec crude oil capacity growth through to 2026. And, even if the IEA’s forecasts prove accurate, it seems dubious to assume all of 1.7mn bl/d of Iranian capacity will remain unavailable to the world oil market for the next six years.

The effectiveness of America’s secondary financial sanctions against purchasers of Iranian crude is increasingly up for debate—the IEA is, notably, among the most conservative analysts in estimating how many grey-market barrels are ending up in China, for example. And there is also a reasonable possibility the Biden administration will ultimately drop sanctions, given Iran appears to have adhered to the nuclear deal until long after President Donald Trump abrogated it.

Petroleum Economist