Oil demand growth has undershot expectations in H1 2017, removing support to oil prices just when the market needed it most. Globally, demand expanded by just 900 thousand b/d in H1 2017. This paltry figure was followed by a modest acceleration to 1.1 million b/d in Q2. In essence, global oil demand ran at just half the growth rate of the last two years.
This should not be overlooked. While it is true that supply is largely to blame for lower oil prices, oil demand has failed to improve at the speed required to rebalance the global oil market. While most investors blame supply for today’s low oil prices, demand has also failed to improve at the speed required to rebalance the global oil market.
Looking into H1 2017, we now doubt that demand growth will accelerate sufficiently and see downside risks to our forecasts of 1.3 million b/d in both H1 2017 and 2018.
In the absence of a mirroring supply response, softer consumption could push 2018 balances into surplus. Put differently, demand will not break the current downward price momentum for now.
…failing to help soak up some of the excess crude and products
What is behind this weak demand picture? The first quarter saw pretty broad-based weakness across a number of big oil consumers in the Americas and Asia ex-China. In EM, demand in Q1 increased by less than 800 thousand b/d, the lowest rate of growth in 13 quarters.
We previously pointed to transitory factors, such as the Indian demonetisation, the Mexican energy reform, as well as the sharp cyclical downturn in Brazil and Russia, to explain why demand growth contracted in EMs. For the US, we pointed to a warm winter.
However, the soft backdrop seems to have lingered on in Q2, not too dissimilar perhaps to the US economy. What is worse for the oil market, the demand weakness has now also spread to other regions like Europe, China, Korea and parts of the Middle East.
Even the US is not managing to shake off a bout of demand weakness. This suggests that cyclical, rather than solely transient, factors are perhaps also at play here.
The oil demand growth bounce in H1 2017 could end up disappointing…
From an oil demand perspective, there are still some good reasons to assume that oil demand growth will bounce back in the second half of this year, partly making up for some of the weakness witnessed in the first half.
The demonetisation story in India, as impactful as it was, is clearly evaporating right now and Indian demand for oil products is bouncing back rather strongly. Diesel demand in May is up 130 thousand b/d YoY to a record high, while total Indian demand is up 200 thousand b/d.
On a yearly comparison, Chinese demand growth may also improve somewhat from depressed activity levels in the second half of last year when forced factory shutdowns and flooding depressed demand.
…as cyclical indicators have moved sideways, with the exception of air traffic
The cyclical backdrop may be too weak to push oil demand sharply higher from here and so the bounce may end up disappointing. It is true that there is little evidence of a synchronised global growth slowdown at this point, merely a sideway move in activity. Until the latest data in March, world trade was expanding at four per cent YoY, painting a rosier picture than it has done at any point since 2011.
However, exports out of the world’s major manufacturing centers have since moved sideways, suggesting that external demand has softened up. Container loadings at major ports in Korea and Hong Kong have failed to accelerate.
Moving to transportation by air, international air passenger demand is probably the only bright spot as it has been growing at the fastest pace in six years. Likewise air cargo travel is supported, in turn keeping demand for jet fuel elevated.
The world is facing softening aggregate demand growth…
Overall, it is hard not to notice cyclical red flags which risk offsetting some of the expected rebound in H1 2017 and 2018. From a macro perspective, a deep data dive suggests that in most places economic activity is either moving sideways or already turning south. Rarely do we find cases where growth is accelerating.
In the US, China and Asia more broadly economic data have surprised to the downside lately, as has inflation. Core durable goods orders for instance have been flat for three consecutive months.
Housing starts are declining sharply. Moreover, the three month moving average of nonfarm payrolls slowed in May to the most sluggish pace since 2012.
Clearly, the uncertainty around tax reform has started to dampen sentiment and confidence, with negative consequences for investment and hiring decisions. In Asia Pacific and Japan, economic data and inflation has also started to roll over. In Latin America, the situation in Brazil is unstable leading us to halve our GDP growth expectations for next year to 1.5 per cent.
Europe stands out as a bright spot though even here, cyclical data has started to soften and suggests a small deceleration from here. All in, it is perhaps fair to say that there are downside risks to our global GDP growth forecasts in 2018 (2017: 3.5 per cent, 2018: 3.8 per cent).
…with China slowing down in front of our eyes
But nowhere is the cyclical slowdown as plain to see as in China. Electricity generation or steel and cement production are all softening up, suggesting that growth momentum has peaked already, and industrial production may start to turn soon, too.
Our economics team expects intensified credit tightening in the off-balance sheet space to keep onshore funding costs high, while on the back of that M2 growth just slowed to a record low 9.6 per cent resulting in slower credit growth.
The most direct channel from tighter financial condition is to fixed asset investment which has already been slowing faster than expected. Retail sales are moderating while auto sales are slowing drastically, suggesting some spillover to the consumer has already taken place.
We increasingly worry that China could overshoot on credit tightening, creating downside risks to GDP growth as well as downside risks to raw material imports.
After all, there is a tight relationship between credit and oil demand as a one per cent change in loan growth is associated with a 0.6 per cent change in oil consumption. Reduced loan growth may withdraw support for oil demand and many other commodities, too.
Bahrain, Gabon, Oman most vulnerable oil exporters
Many frontier markets remain highly vulnerable – especially to oil price weakness – as fixed exchange rates and lack of policy capacity delayed the adjustment. Most vulnerable among the 68 economies we cover are Bahrain (largest fiscal deficit), Oman, Tunisia, Mozambique (widest current account gap) and Belarus.
Nigeria is still the strongest among the Sub-Saharan African markets with sovereign Eurobonds, owing to favourable stock indicators in external and public debt and low domestic private leverage.
Considering the latest weakness in crude prices, we replicate our first chart of the average fundamental ranking specifically for the oil exporters.
Bahrain, Gabon and Oman have on average the weakest fundamentals. Venezuela is the weakest among the big index weights. Russia is the oil exporter with the best fundamentals thanks to prudent fiscal policy in the good times and the frontloaded adjustment to the decline in crude prices during 2014-15. Kuwait remains the fundamentally strongest GCC market.
Among the African crude exporters Nigeria remains the relatively strongest thanks to the savings during the period of high oil prices. Moreover, due to import compression and some recovery in crude export volumes the basic balance (including net FDI) is actually back in surplus during the past 12 months. However, this unfortunately has limited the urgency to reform the unsustainable currency regime, in particular.