Oil prices may have recovered over the past 15 months but that’s unlikely to last, says JP Morgan’s global commodity research team.
In a note released following the decision from OPEC and non-OPEC members to extend production cuts last week, the bank argues that prices are likely to weaken once again, citing continued growth in US shale oil production and the possibility that the deal to extend production cuts may unravel before its scheduled expiry in March next year.
As such, the bank has made large downward revisions to its price forecasts, lopping $10 and $11 respectively on its average Brent and WTI price for 2018.
Here’s the bank’s latest price forecasts.
David Martin, executive director at JP Morgan, says the decision to lop its crude forecasts was driven by the expectation that the deal to extend production cuts will likely fail, which, along with higher US production levels, will lead to an increase in global supply.
“As we have previously flagged, the longer-term consequences of OPEC’s actions will likely prove unpleasant for the cartel’s members,” he says.
“We assume that the OPEC/non-OPEC deal collapses at the end of 2017, as cheating becomes untenable for core OPEC members. Consequently, the 2018 oil market balance now points to rapid builds in inventories which, absent continued OPEC support, should depress oil prices.”
Contributing further to price weakness, Martin says that US production levels are still likely to increase for several quarters yet given lower breakeven costs for producers and increased investment as a result of previous price strength.
“If we are proved correct, we do not expect shale capital expenditure to start to decline until mid-Q1 2018,” he says.
“As a result, US rig activity may continue to rise for the early part of next year and therefore the production impacts on US shale are assumed to really start from mid-2018 onwards.”
Given these factors, Martin says that it should “crush the prospects of higher prices next year”.
While this will create renewed financial pain for producers in the short-to-medium term, Martin says that price declines will be required to curb industry investment in non-OPEC nations, mirroring the scenario that played out in 2014 and 2015 when a collapse in prices led to a sharp decline in US shale investment.
“The need for non-OPEC to again shoulder the burden of adjustment is likely to prove as painful as before for producers in OPEC and non-OPEC alike. Arguably more so, as shale breakeven price levels have fallen substantially in the past 6-12 months for best in class and median shale producers alike,” he says.
“Shale producers and OPEC can survive in a world where demand growth remains healthy and where mature field decline in conventional production is accelerating. This last factor still does not appear to be dragging on supply.
“Arguably, oil prices will need to accelerate this process, but in doing so a return to sub $40 per barrel may yet be unavoidable.”