Economic uncertainty, Covid-19 and oil prices

THE ONSET of the Covid-19 pandemic in the first quarter of 2020 saw crude oil prices steadily decline, briefly falling into negative territory largely due to a collapse in demand for petroleum. On the supply side, the Organisation of Petroleum Exporting Countries (OPEC) and its allies supported prices by trimming output. While there are nascent signs of recovery in the global economy, the outlook is marred by significant downside risks due to the evolution of the pandemic and the rollout of the vaccines as well as the emergence of new strains of the virus, which may add further economic uncertainty. Accordingly, global oil prices are forecast to show limited upside into 2021, mirroring the uncertainty of the economic recovery.

During 2020, crude prices averaged close to US$40 per barrel (bbl), peaking at US$63 in early January and briefly plunging into negative territory to close at –US$37.63 bbl on April 20 due to a rapid accumulation of inventory as well as a price war between some of the large producers of the OPEC+ group. Since the April price crash, prices have stabilised and continue to trade just around the 2020 average, ending the year at US$48.52 bbl, 21 per cent lower than 2019’s closing price and well below the ten-year average price of US$60.45 bbl.

As the pandemic swept through the global economy, both demand for, and supply of petroleum fell sharply relative to 2019. According to the US Energy Information Administration (EIA), world oil and liquid fuels production fell by 6.3 per cent to 94.25 million barrels per day (bpd) from 100.61 million bpd in 2019, and output is expected to recover only to 97.42 million bpd next year. On the demand side, consumption fell by 9 per cent in 2020 relative to 2019 to 92.4 million bpd. In 2021, the EIA forecasts that world consumption will remain below 2019 levels, rising by just 6 per cent in 2021 compared to 2020.

The OPEC+ countries have also helped to steady the market, undertaking the largest and longest production adjustments in history in response to the pandemic shock. OPEC noted that between May and November, ‘participating OPEC and non-OPEC countries contributed to reducing the global supply by approximately 1.9 billion barrels, including voluntary adjustments, and this has been key to the rebalancing of the market’. At its January 5, 2021 meeting, in a surprise move, Saudi Arabia pledged a unilateral production cut of an extra one million barrels a day in February and March, while other members opted to hold output steady. Further, both Russia and Kazakhstan chose to boost output in February and March. In its press release, OPEC+ noted that “rising infections, the return of stricter lockdown measures and growing uncertainties have resulted in a more fragile recovery that is expected to carry over into 2021”.

As the meeting concluded, the market reacted positively, as prices rose to a ten-month high, topping US$50 bbl. Adding to the rally in oil prices has been the colder winter weather in the Northern Hemisphere as well as in Europe and particularly Asia, which has increased demand for heating, supporting the rise in commodities such as crude oil, gas and coal.

Notwithstanding the recent developments which may support a temporary rally in oil prices, significant headwinds taint the outlook. After contracting 4.3 per cent in 2020, world GDP growth of 4 per cent is projected for 2021, according to the World Bank. This represents a downward revision from June 2020’s forecast and was due to a resurgence in the number of Covid-19 cases worldwide. Notably, the 2021 growth forecast for the advanced economies is now at 3.3 per cent mainly due to downgrades for the US and Euro Area. In its October 2020 World Economic Outlook, the IMF projected growth of 5.1 per cent for the global economy after a 4.4 per cent contraction in 2020.

The heightened economic uncertainty will weigh on the outlook for crude oil, despite limited price support in the short term. The forecasts for oil prices show relative stability at just under US$50 bbl based on data from Bloomberg. The US EIA also projects WTI prices to end 2021 at US$45.78 bbl and Brent crude at US$48.53 bbl. With oil prices expected to trend well below the ten-year average in 2021 and beyond, coupled with the increasing trend towards renewable energy in the long term, the outlook for oil prices remains bearish and may necessitate more proactive policy decisions for commodity exporters globally.

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