The last decade saw significant shifts in the global energy landscape, ultimately changing supply drivers and prices across the transportation energy continuum. The next decade will undoubtedly bring a quicker pace of change to the transportation energy portfolio. From a transportation management perspective, these shifts have an impact on the underlying costs of moving goods to market.
Starting in 2005 and peaking in recent years, the U.S. shale oil boom was one of the largest drivers of the shift in global crude oil production. The U.S.’ new-found energy security and production dominance enabled more aggressive foreign policy and heightened geopolitical risk among numerous oil-rich nations.
The demand side of the global oil equation is also changing. After over a decade of U.S. economic expansion, both advanced and developing economies alike are facing new challenges that limit refined product demand growth. Add in the move to lower-carbon-intensity fuels and regulations to clean up conventional fuels, and the demand for traditional energy types—gasoline and diesel—will continue to evolve the energy demand in the decade ahead.
The Shifting Balance of Crude Oil Supply Will Continue to Influence Pricing Dynamics
The 2010s were highlighted by United States crude oil expansion, thanks to the shale oil boom. In total, U.S. oil production grew from 5.5 million barrels per day (mmbd) in 2010 to 12.3 mmbd in 2019. This expansion far outpaced that of any other nation, ultimately making the U.S. the world’s top oil producer in 2019–surpassing historical top producers like Russia and Saudi Arabia. Heading into 2020, the U.S. looks to continue to increase oil production, but likely at a lower rate of growth.
According to Jenny Vander Zanden, COO at Breakthrough, this evolution is causing ripples across the industry. “With the U.S. becoming such a dominant player, we are seeing the behavior of other key stakeholders begin to shift.”
The growth of U.S. production in the last decade came with a change in strategy from the previously dominant stakeholder, the Organization of Petroleum Exporting Countries (OPEC).
From 2014 to 2016 crude oil prices fell when OPEC tried to maintain market share in the face of rising U.S. production. This led to an oversupplied market, bringing prices from $120 per barrel to $25 per barrel at its lowest point. This market share strategy put a small dent in U.S. production and ultimately renewed OPEC’s commitment to balancing global oil markets.
OPEC’s new strategy also led to the cooperation of select non-OPEC oil producers—Russia being a key ally—which created the group known as “OPEC+.” OPEC+ accounts for roughly 45 percent of total global oil production. To date, the cartel has removed roughly three percent of world oil production through their quotas since 2017, coming as a direct response to the dip in prices seen in previous years.
“With the U.S. operating more independently, OPEC made some strategic decisions to try to maintain control over prices. By adding in this group of allies, they’re attempting to build up the market share they can control, but it has been hard to keep pace with the U.S.’s rapid production increases,” says Vander Zanden.
Oil supply and prices in 2020 will continue to rely heavily on the dynamics of U.S. oil production and the consequential response of OPEC+. U.S. crude oil production growth will likely continue at a rate that limits upside price risk from supply shocks around the globe. U.S. production growth is slowing, however, because U.S. producers need to balance shareholders’ desires for increased returns following a decade of rapid expansion and significant capital spending
OPEC+ instituted deeper cuts for the first quarter of 2020, though their direction beyond that is uncertain. It is likely that OPEC+ will continue to balance the global oil market—bringing with it a continuation of rangebound price behavior—but an unlikely shift back to growing market share poses a significant downside price risk.
Ultimately, the offsetting forces of U.S. and OPEC+ crude oil production lead us to believe the market remains comfortably supplied and upside price risk is limited.
The Uncertain Geopolitical Scene Will Continue to Offer Short-Term Price Volatility
Geopolitical tensions put the global oil supply and prices at risk throughout the 2010s. More recently, this occurred with U.S. President Trump’s withdrawal from the Joint Comprehensive Plan of Action (more commonly known as the Iran nuclear deal) in May 2018. The U.S. continued to rachet up pressure on Iran via sanctions on Iranian oil exports, leading to a 46 percent decline in Iran’s oil production to just over 2.0 mmbd to end 2019.
Interested in how the U.S. – Iran tensions have affected wholesale diesel prices?
The pressure on Iranian oil exports led to the growing tension in Iran’s relationships with many foreign governments. This came to a head when Iranian-led drones attacked Saudi Arabian oil infrastructure in September 2019, which were shortly followed by U.S.-ordered strikes that killed Iranian military leader Qasem Soleimani in January 2020. The conflict continued with retaliatory strikes by Iran on two Iraqi bases that housed U.S. troops within the following week.
These events had short-term pricing implications but have not significantly changed the trajectory of oil and refined product pricing. A larger-scale conflict throughout the Middle East would have significant price and supply ramifications, especially if relations between Iran and the U.S. or other surrounding nations continue to dissolve.
Read a deeper analysis of how U.S. – Iran tensions developed over this time period and the resulting impact on global crude oil prices here.
Other areas of the world also add risk to global oil supply and prices, though they may not capture the same headlines as Iran. Venezuela’s oil-dependent economy has continued to be crippled in recent years, exacerbated by more stringent U.S. sanctions placed in January 2019. Venezuela’s oil production has declined over 70 percent in the last five years and 45 percent during last year alone. This production is unlikely to turn around soon, even if a civil movement for regime change succeeds.
Two African nations—Libya and Nigeria—continue to struggle with civil conflict that targets oil infrastructure, which poses risk to global oil prices (though this price pressure has been more limited with the U.S. production boom).
Vander Zanden says, “When you look at the big picture of how U.S. relations are affecting the global market, you can really start to draw the connections to shippers on a more micro-scale. Even though U.S. energy growth has brought a bit of stability to prices, foreign relations have created significant risks that have made setting budgets a real challenge.”
The risk of a major oil supplier being disrupted during 2020 remains high. Market fundamentals will likely limit the long-term impact of such risks. Therefore, our perspective is geopolitical disruptions will continue to be high-risk but low impact during 2020.
Growing Economies Increase Crude Oil Demand, Despite Trade Uncertainties
Crude oil demand is tightly intertwined with global economic performance. Growing economies create demand for crude oil and its corresponding refined products—especially that of diesel which remains among the most economically-sensitive refined products.
On the demand side of the oil equation, the continuation of over a decade of economic expansion across many economies led to significant growth in oil demand. In total, global oil demand grew from 88.6 mmbd in 2010 to 99.9 mmbd in 2019 (a 12.8 percent increase in total).
This oil demand growth was underpinned by annual global real GDP growth that continued at or above three percent for each year in the 2010s, according to the International Monetary Fund (IMF). Specific to the U.S., economic growth has persisted, but at an annual rate of 1.6 to 2.9 percent over this same time period. The IMF has projected economic growth for all major economies over the next five years, though U.S. and world real GDP growth is not projected to exceed the average of the last decade.
The evolution of U.S. trade policy had a volatile impact on global economic growth and crude oil price outlooks. Trade relations with North America caused ripples in equities and commodities markets, though both fronts moved positively heading into 2020.
Trade relations between the U.S. and China—the world’s two largest economies—brought greater volatility to the global scene. Both nations have reasons to strike a deal to spur their growth outlooks, though issues like a growing trade imbalance, intellectual property protection, and cybersecurity risks complicate the on-going dispute. The tariff escalations over 2019 also brought about continual declines of the global economic demand outlook.
The January 2020 signing of a phase 1 trade deal between the U.S. and China brings hope for an improved economic outlook in the year to come. Initially, the positive news led to an improved global economic growth outlook in 2020 when compared to 2019. Challenges still lay ahead, as both China and the U.S. must make good on their phase 1 agreement and work towards further phases without tariff escalation.
Failure by the U.S. to make progress in its trade talks with major trading partners including China, the EU, and Japan, among others, could put significant downward price pressure on crude oil and refined products. This could prove to be disruptive for expectations of emerging and developing economies, particularly in Southeast Asia, experiencing an economic turnaround in 2020. Their demand growth is presently anticipated to add upward pressure to prices during the second half of this year.
The January outbreak of a coronavirus in China offers a new shock to consider for fuel demand. Many comparisons of the new virus have been made to SARS but the market experience is likely to be different. China’s GDP has grown from less than five percent to nearly 20 percent of the world’s GDP since the SARS outbreak in 2003. The virus may prove to be disruptive for quarters to come, leaving economic growth and energy demand below their potential and, as a result, dramatically soften prices.
Energy Market Trends and The Impact on Shippers
In the decade to come, a push for more environmentally sustainable transportation fuels will begin to displace world crude oil demand. Consumer and investor preferences, and government regulation, are strengthening global efforts toward the abatement of greenhouse gas emissions.
This trend is not new. The U.S. began its move to ultra-low sulfur diesel nearly a decade ago. Increased regulations on local pollutants like nitrogen oxides (NOx) and particulate matter (PM), and renewable fuels programs like biodiesel, ethanol, and renewable natural gas (RNG) have been prevalent in domestic transportation energy networks today.
On the global scale, the latest example of this regulatory push is the increased regulation on sulfur emissions set by the International Maritime Organization (IMO) implemented in January. Commonly known as IMO 2020, this effectively lowers sulfur emissions by 86 percent for vessels traveling on the open seas. This change is introducing a new fuel type into the marine landscape and will create new supply and price pressures for the movement of goods internationally.
Additionally, the trend towards the regulation of cleaner fuels is likely to continue across all transportation modes, ultimately bringing pressures for refiners and end-users alike.
Read more about how to “Navigate the Ripple Effect of Tightening Emissions Standards.”
It is important to note, the historic reliance on crude oil and its refined products for transportation energy will diversify in a meaningful way in the years ahead. This diversification will create opportunities for companies actively managing their transportation energy, with possible on-costs and difficulties for companies that stick with the status quo.
**Market fundamentals and geopolitical impacts on transportation fuel prices are covered in-depth on a monthly basis in exclusive Breakthrough client publications. For more information, contact us.