According to the International Energy Agency, crude prices are set for a slow recovery. In its base scenario, it forecasts that the market would rebalance at $80 per barrel in 2020, with the potential for further price increases afterwards.
Even more concerning, the agency predicted the potential for a permanent change in how the oil market works. Although less likely than its base case, it warned that a new oil market equilibrium may emerge "at prices in a $50 to $60 per barrel range that last until well into the 2020s before edging higher to $85 per barrel in 2040." The necessary factors for this outlook are sluggish near-term economic growth, a stable Middle East in which key producers look to increase their share of the market and resilient performance from key non-OPEC producers, particularly U.S. tight oil. That may not be such a low probability event.
At the end of the day, the mechanisms influencing the price of oil have changed forever with the shale revolution. Shale plays can respond quickly to price changes, varying investment in rapid fashion. This is very different from the supply-side response of the past, where production could be reasonably predicted based on longer upstart cycles. This means that whenever oil starts to stage a rebound, shale players can quickly attack the margin by boosting production.
This effectively puts a price ceiling on oil. As you can see from the chart below, U.S. tight oil production starts to ramp up at around $70 a barrel. Breaking through that level would require a supply response elsewhere (which OPEC has been unwilling to provide) or a rise in demand. As we'll see, a demand response is simply not on the horizon.
The largest demand stories are near their end. China, long the market's biggest contributor of oil demand growth, is set to plateau for decades. The incremental demand should be met with renewables and natural gas, not oil.
The U.S. meanwhile, the largest consumer of oil in the world, is set for declining demand, as will the E.U. and Japan. While overall demand will still rise, it won't be enough to match the new supply-side paradigm of quick market responses and cheap production.
Until at least 2020, shale production should be able to bring on high supply. While many regions are now producing supply dips, this doesn't change the amount of reserves that are in the ground. If oil were to approach $70, expect much of this supply to be brought to market in short order. It would be very difficult to predict any meaningful upswing in oil prices until at least 2020.
