With commodities and goods such as coal, LNG, and computer chips commanding eye-popping prices, Bank of America analysts are predicting a return to triple-digit crude oil prices this winter. While we do not rule out that crude prices will flirt with $100/barrel sometime this winter, we regard this development as unlikely. Sustained $100/barrel prices are even less likely, as OPEC+ and China have no interest in seeing a return to triple-digit prices. A massive run-up in crude oil prices would not only sharply increase the probability of a Chinese economic recession (or even a financial crisis), but it would also likely accelerate the energy transition. Although OPEC+ might miscalculate, we believe that the cartel’s own self-interest, Chinese pressure, and, potentially, Iranian/Venezuelan/U.S. shale volumes will restrain crude prices.
World crude demand: returning, but with risks
The highly-transmissible Delta coronavirus variant has buffeted the world economy in the second half of 2021, with most economies projected to grow more slowly than predicted earlier in the year. The U.S. Federal Reserve now predicts U.S. 2021 real GDP growth will total 5.9% – respectable, but well below the June projection of 7.05%. Chinese economic growth is more fraught and uncertain. Although the world’s second largest economy appears to have contained the Delta variant, its real estate sector is facing a serious challenge. The S&P 500 fell nearly 2% on September 20th on default fears surrounding Evergrande, a Chinese property developer. If the Chinese real estate market stumbles or crashes, world crude oil demand could face significant or even sharp headwinds.
While we won’t get into the details of Evergrande and the Chinese real estate sector, we regard the probability of a Chinese financial crisis as low to moderate. Much more worrisome, however, is the country’s medium-term to long-term growth potential. Many economists are projecting sharply lower Chinese real GDP growth rates for the next decade – perhaps even lower than 2%. The implications for crude oil demand could be enormous.
BP estimates China’s share of all world oil consumption at 16.1%. Since the property sector accounts for as much as 25% of Chinese GDP and is relatively energy intensive, we therefore estimate that the Chinese property sector alone accounts for at least 4-5% of total world oil demand. A long-term, secular slowdown in Chinese GDP growth – or even just in the Chinese property sector – could therefore constrain crude oil demand in the medium-term.
What could high energy prices trigger?
Many analysts believe that a Chinese financial crisis is unlikely in the near-term, although they regard the medium and long-term risks of an economic slowdown as very serious. An energy crisis in the form of $100+ Brent prices could change this calculus, however, by significantly increasing the probability of a near-term liquidity crisis in the Chinese real estate market. A run up in oil prices would increase costs at already-vulnerable Chinese real estate developers while pressuring revenues. This dynamic would severely damage liquidity at China’s highly-leveraged real estate producers, potentially igniting a financial crisis.
High energy prices can certainly contribute to real estate crises: while the 2006 – 2008 US housing bubble burst for many reasons, crude prices played an important and underrated role. Due to OPEC+ miscalculation, WTI prices peaked at $145/barrel in July 2008 before falling to $38/barrel by December 2008, during the darkest days of the Great Financial Crisis. Another sugar-high increase in crude prices could lead to another sharp crash – only this time around, investors might leave the industry for good.
A sharp rise in oil prices would also likely incentivize more production to come online. While U.S. shale has become much more disciplined and will respond only modestly and cautiously to higher prices, Iran and Venezuela have the capacity to add (at least) a million barrels per day to the market. If prices continue to rise, Washington, Tehran, and Caracas will all have greater incentives to reach a diplomatic understanding.
Has OPEC+ learned its lesson from 2008?
Another policy mistake from OPEC+ could prove highly damaging to the entire O&G complex: it isn’t 2008 anymore. EVs and renewables are no longer niche players and present a highly credible long-term challenge to hydrocarbon demand. Given the risks of another 2008-style meltdown and an accelerated energy transition, we believe that OPEC+ producers will increase production to prevent a price surge (particularly if they come under pressure from China, the world’s largest crude importer). There probably won’t be an oil crisis and we don’t believe that crude prices will return to $100/barrel.