From the Economist’s Chair: Paint It Bleak

Author David Fyfe, Argus Chief Economist

As summer arrives and the world emerges from lock-down, hopes are high for gradual economic and oil demand recovery. Alongside reasonable levels of Opec+ discipline, this could help place a floor under crude prices. But whisper it quietly, a bleaker scenario also exists, even if for now it remains a market tail risk.

The June issue of Argus Fundamentals highlights the major strides already made by Opec+ producers that could eventually allow stockpiles from the 2Q20 demand collapse to drain. Opec crude production alone fell to nearly 24 mb/d in May and likely lower still in June. Given a fair wind, producers may indeed succeed in helping create more supportive market fundamentals, with stock overhang potentially gone by late-2021. Provided demand recovery holds, US shale supply rebounds at a modest pace and Opec+ cohesion persists, then Saudi Arabia, Russia and colleagues can expect higher market share over the medium term.

So far, talk of a more bearish scenario has tended to focus on shale rebounding at the rapid clip it managed during 2017-2019, or Opec+ failing to collaborate to manage the market. Less attention has been given to the real elephant in the room – a second peak in Covid-19 requiring renewed, widespread economic lock-down, otherwise known as the “double-dip” scenario. This would seriously delay demand recovery, rendering Opec+ market management largely futile and hammering US producer finances even harder than has already occurred.

To be clear – this nightmare scenario is neither the base-case outlook from major economic forecasters or ourselves. Gradual recovery remains the central case in most outlooks. However, recent secondary spikes in infection rates in Beijing, Brazil, parts of the US, India and the Philippines suggest it is prudent to at least consider the scale of any future double-dip event.

World GDP trajectories

Oxford Economics last week published a note highlighting one potential macro-economic pathway in the event that double-dip materialises. A second wave of the virus is more likely if lockdown restrictions are eased before the first wave of infections has been adequately controlled. And with uneven testing and tracing capability potentially impeding “smart”, targeted intervention, renewed blanket lock-downs in the second wave would risk prolonging economic recession.

Even the current, more benign recovery scenario leaves global economic output by end-2022 some 2-3% below pre-Covid forecast levels. Similarly, late-2022 global oil demand under our base case is likely to remain 2 mb/d below end-2019 levels, as social distancing and restrictions on international travel persist well into the future.

Despite all the signs of nascent oil market recovery, it’s worth noting that June’s Argus Fundamentals forecast shows this year’s oil demand fully 10 mb/d below the January 2020 outlook, made before the virus fully took hold internationally. Nor does that gap get fully closed in 2021 and 2022, even under the recovery scenario.

Base-case global GDP growth (PPP basis) is seen averaging -4.6% this year, +6.6% in 2021 and +4.5% in 2022, with recent projections already factoring-in a heavier Covid-19 hit on Emerging Markets. Oxford Economics’ “double-dip” scenario implies a steeper -5.4% GDP drop this year, and a further -2% contraction in 2021, before a +5.5% recovery in 2022.

What double-dip might mean for oil demand

Simple oil demand/GDP models are prone to break down at times of exceptional disruption such as Covid-19. Indeed, oil demand impacts so far in 2020 already outstrip those suggested by simple income models, not least as mandatory lock-downs have disproportionately hit the core transportation sector, where oil demand is concentrated.

Nonetheless, this thumbnail sketch of possible double-dip impacts suggests a further 6 mn b/d could be knocked off 2021 oil demand, with 2022 oil demand also potentially 3 mn b/d below anticipated base-case levels. Of course, a second virus wave of this magnitude remains far from certain. However, the sheer scale of impact on oil demand should give Opec+ and US shale producers alike plenty food for thought over the summer season.

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