Fitch has released its latest outlook for Brent, and the rating agency maintains the quarter with forecast benchmark to average USD72/bbl in 2021, falling to USD69/bbl in 2022. It expects the market balance to remain tight over second half. Supply will rise: OPEC+ has agreed to return 400,000b/d every month between August and December, while shale production has returned to low levels of growth, led by the Permian. However, in the face of renewed outbreaks of the coronavirus globally, oil demand will also continue to normalise, outpacing the growth in production.
From 2022, the outlook becomes more clouded. The economic recovery will have passed it peaks, with momentum
slowing and oil demand growth decelerating. At the same time, rising volumes from the US, OPEC+ and, prospectively, Iran, will substantially increase the supply availably to market. Our global supply and demand balance point to a large glut next year, which may only partly be offset by firming sentiment as the pandemic fades.
The highly transmissible Delta variant – first documented in India in October of last year – has now spread to 132
countries globally. Vaccinations are proving effective in preventing severe illness and death, but less so in preventing the transmission of the Delta variant to others. The data are still mixed, but some recent studies have suggested that viral loads may be similar among the vaccinated and unvaccinated, albeit declining more rapidly among the former. This undermines the assumption that vaccinated populations are at low risk of spreading the virus. The upsurge of infections has led to a number of governments revising their social distancing guidance and domestic containment measures, even in markets with high vaccination rates, such as Israel and the US.
The downside risk to prices may operate through market sentiment or the underlying fundamentals. The spread of the virus raises the risk of more widespread restrictions and a slower pace of economic recovery, which would in turn undercut demand. However, demand destruction stemming from the Delta variant appears to have been relatively limited in most markets to date. In general, the spike-up in infection rates has not been associated with the same curbs on mobility as was seen during previous outbreaks
In the EU, UK and US, where vaccination rates are relatively high, a number of countries have seen population mobility continuing to increase, even as Covid-19 cases have surged. Moreover, in several cases, the peak of infections appears to have passed, without the use of more stringent containment measures. In part, this is due these countries’ success in decoupling infection rates from the number of hospitalisations and deaths. Since the start of the pandemic, there has been a constant tension between policy steps designed to minimise economic damage and those aimed towards optimising health outcomes. With wider vaccine uptake, pressures on the healthcare system have been eased, and governments have come under less pressure to step-in and curb infection rates.
Even in those markets where vaccination rates remain low – as is the case in many emerging markets outside of China – more recent outbreaks have often been accompanied by smaller reductions in mobility. Many factors are likely at play here. Lockdown measures have generally become more targeted, seeking to promote containment while limiting the economic fallout, while populations have now had more time to adjust and adapt to these restrictions. There is also a growing fatigue with the pandemic and its impacts, which may be lessening compliance with government directives. For their part, many governments appear unwilling to impose strict lockdowns, for fear of the economic fallout and attendant social unrest.
Where vaccination rates are low, higher infections are still translating into higher fatalities. As a result, for many
countries the worst outbreaks of the virus have occurred this year. This includes a number of major EM oil consumers, such as Brazil, India, Indonesia, Iran, Malaysia, Mexico, South Africa, Turkey. Where infection rates spiral out of control and healthcare systems begin to crack, the government will be more likely forced to act, as was notably the case in India. Given that vaccination rates will remain low among many EMs well into 2022, risks from new variants will remain elevated over the coming quarters. Asia is somewhat of an outlier here, given that governments in the region have tended to respond to new outbreaks with more stringent lockdowns than are common elsewhere, most recently evidenced by the widespread stay-at-home orders issued in cities across China. Given that we estimate that the region will account for around 35% of global growth in 2021, dynamics in Asia are of importance to the wider oil market too.
While outlook for the year remains broadly bullish, we are forecast a far slower pace of growth: at 5.7%, forecast
is little over half of the 10.6% average seen over the past five years. The forecast assumes that, as was the case withprevious government crackdowns in 2016 and 2018, imports will largely normalise after few months, once the
independents adjust to their new operating conditions. In the meantime, reduced competition from independent
refiners may improve prospects for SOEs. The domestic fuels consumption outlook is broadly bullish, with demand
having returned to its pre-pandemic highs. And, although growth will slow, the ongoing normalisation of middle distillate consumption will help to buoy consumption over the coming quarters. That said, the risks to the forecast are likely skewed to the downside. The resurgence of Covid-19 is dampening the export market in Asia, which could depress run rates, given that Chinese refiners rely on exports abroad. Meanwhile, higher crude prices will pressure refining margins, while disincentivising strategic stockbuilds. The pace at which the independents will adapt to new market conditions is also a key unknown at this stage.
The Jet Fuel Recovery
The main upside risk to demand stems from a meaningful revival in jet fuel demand. The recovery in jet fuel demand has lagged the wider fuels basket. Air freight has largely normalised, with IATA reporting 9.9% and 8.5% growth in June and May, respectively, compared to their 2019 equivalents. Moreover, the outlook for air cargo is constructive, supported by strong demand for goods globally, low inventories-to-sales ratios and cost competitiveness against alternative transport modes. However, the air passenger market is struggling to recover. IATA reports that travel was down from 2019 levels by 60.1% and 62.9% in June and May, respectively. And while the market is ticking up, month-on-month gains remain relatively modest. Market conditions vary widely at the domestic level, which is dragging down on global growth.
The Chinese Slowdown
Strong crude import demand in China has provided a key pillar of support to prices over the past 18 months. However, the outlook for imports has clouded, following a regulatory clampdown by Beijing. The government has moved to tackle the illegal trading of state-issued import quotas among non-state refiners (see ‘China Crude Import Outlook Bullish Despite Crackdown Against Independent Refiners’, June 17). Under the current system, independent refiners are awarded crude quotas biannually, with the volumes calculated according to various technical and environmental criteria, as well as previous import levels. However, some refiners have been able to purchase and process crudes above their quotas, by illicitly buying quotas from others. The result has been a domestic fuels glut, rising competition for SOEs, reduced sector profitability, lower tax revenues and higher emissions levels. In response, the government has reduced the crude import allowances awarded under the second batch of the year, with some refiners denied quotas entirely. In addition, it has levied new taxes on some alternative fuels, including light cycle oil, mixed aromatics and bitumen blends, which independent refiners have been substituting for crude, to raise their run rates.
More significant, though, are the widespread and ongoing limitations on international travel, which accounted for around 45.7% of total revenue-passenger kilometres in 2020. Accelerated vaccine roll outs and the rollback of travel restrictions should help to raise jet fuel demand over the coming quarters. A faster-than-anticipated rebound in passenger travel would surprise the market to the upside, firming up sentiment and further tightening the market