The price of oil has been volatile over the summer months.
For the first time since 2021, Brent crude oil dropped below $70 per barrel. While it didn’t stay below $70 for long, it also didn’t rebound much higher and recover the lost ground – so far this year the oil price has fallen more than 7%.
But why is the price of oil falling, what does it tell us about the macro economy, and how it could impact financial markets.
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Organisation of the Petroleum Exporting Countries (OPEC) is an intergovernmental organisation that control a large amount of the world’s oil supply. OPEC can therefore organise oil supply cuts and increases to influence the price.
Demand concerns grow
The oil market is large and complex. It’s driven by supply and demand factors. OPEC decisions also weigh on the oil price, as does the global green energy transition.
Perhaps the most important driver of the oil price is demand, and demand concerns were one of the key drivers of this summer’s volatility.
The latest International Energy Agency (IEA) report for the oil market, published in September, reported a deceleration in oil demand.
Global oil demand growth for the first half of 2024 was 800,000 barrels per day, the slowest pace of growth since 2020.
This compares with demand growth of 2.3 million barrels per day in 2023.
So why has demand for oil fallen sharply?
The IEA thinks the reason is a slowdown in the Chinese economy. Over the past decade, the annual increase in Chinese oil demand has averaged 600,000 barrels per day. China has been vital for the oil industry, and its global oil demand equated to 60% of all global demand growth.
Why is China buying less oil?
China’s economic picture has changed dramatically. Its GDP growth rate has fallen from a 7.5% annual rate in 2014 to 4.7% in the second quarter of 2024.
The IEA reports that oil consumption in China fell for the fourth straight month in July, by 280,000 barrels per day.
China has been the cornerstone of growth for the oil sector in recent decades, however, it’s not as reliable a customer as it once was, and this is hurting sentiment for ‘black gold’.
Demand outside of China is also worth noting and it’s still 0.3% below 2019 levels. There’s no sign that demand growth in India, the Organisation for Economic Co-operation and Development (OECD) and the Middle East will be able to make up for a slowdown in China.
The Organisation for Economic Co-operation and Development is an intergovernmental organisation, made up of 38 countries, to help stimulate economic progress and world trade.
This problem could linger as China is by far and away the biggest contributor to the growth in global oil demand, as you can see in the chart below.
Growth in global oil demand by region, 2013-2023
Demand is slacking while supply is strong
The oil market has a supply and demand imbalance right now and that is weighing on the oil price.
At the same time that demand growth has been under pressure, oil supply remains strong.
While OPEC has been cutting production in recent years, growth in oil production outside of OPEC has been going from strength to strength.
The EIA in the US estimates that global production of petroleum and other liquid fuels will grow by 0.3 million barrels per day in 2024.
A decline in production within OPEC is cancelled out by production outside of the cartel, including in the US, Brazil and Canada.
Production growth is expected to continue next year, the EIA predicts production will increase by 2.4mn barrels per day in 2025.
The risk is that supply could continue to outpace demand.
The EIA has also revised down their expectations for Chinese liquid fuels demand for 2024 and 2025. That’s thanks to slower economic activity and signs that demand for oil, diesel and petrol are all slowing.
What about oil prices in the long-term?
The long-term outlook for oil demand is also a concern for investors.
The IEA expects oil demand for transportation use to decline from 2026. They also see peak demand for oil soon after, in 2028.
Oil demand in developed nations is expected to fall to less than 43 million barrels per day by 2030, down some three million barrels per day since 2023.
Financial markets are notoriously forward-looking, so the prospect of a weak China combined with a slowdown in overall oil demand has weighed heavily on the oil market this year. However, not all traders are as bearish on the oil industry.
The consultancy company McKinsey predicts that traditional fossil fuels will remain an important part of the energy mix until 2050, while Goldman Sachs predicts that oil demand will continue to increase until 2034, before plateauing.
As you can see, there’s a range of views about the future for the oil market, which could be adding to the volatility.
What does the price of oil mean for stock markets?
The price of oil is also important for financial markets for reasons other than supply and demand.
The oil majors have engaged in massive share buyback programmes in recent years.
Oil supermajors including Exxon Mobil, Shell, Chevron, TotalEnergies and BP spent nearly $114bn on dividends and share buybacks last year, which was up 10% on 2022.
Growth is expected to continue this year. For quarter three 2024, Exxon Mobil has guided that it will repurchase $5bn of shares, Shell is expected to buyback $3.5bn, BP $1.75bn, Chevron $4.2bn, while TotalEnergies is expected to buyback $2bn. On an annualised basis that could equate to $66bn a year.
The reason oil major CEOs are so keen on share buybacks is to boost floundering valuations.
For example, BP has a 12-month forward price-to-earnings ratio (PE) of 6.74x earnings, compared with 11.62 for the FTSE 100 as a whole. Exxon’s 12-month forward PE ratio is 13x earnings, the overall 12-month forward PE ratio for the S&P 500 is 20.
However, will the volatility in the oil price and/ or the slowdown that is forecast for the future of oil demand growth, weigh on share buybacks in the future?
All is not lost for the oil majors
Brent crude oil price
The recent decline in the oil price is not as bad as it seems when you look at the bigger picture.
The oil price still looks like it’s moving in a range, although it’s close to the lower end of this range right now.
The average price of a barrel of Brent crude oil for 2024 so far is above $82 per barrel. This compares with an average price of $74 per barrel in the last five years.
So, when you look at the big picture, the oil price for 2024 looks stable, even if it has experienced periods of volatility. Remember though that past performance isn’t a guide to the future.