Oil Market Fundamentals Suggest 2021 May Recoup Much of 2020 Losses

Dean Foreman
Posted December 8, 2020

Although many uncertainties remain, oil market fundamentals have recently improved along with economic recovery from the 2020 COVID-19 recession, as we discussed here. If estimates from the U.S. Energy Information Administration (EIA) and others prove to be correct, 2021 could recoup much of the growth, spending, investment and energy demand that was forgone this year. 

While 2020 has been an especially challenging year and business climate, what we’re seeing is that the U.S. natural gas and oil industry has resiliently increased its productivity to record levels, lowered its costs and expanded critical infrastructure to reposition for growth in a potential recovery.

A critical question for the United States — its economic growth, energy security and trade balance – concerns who will supply the market if it recovers as expected.

Importantly, will the world increase its reliance on nation-state producers, or will the United States resume its progress as a preferred provider of crude oil and natural gas to global markets?

Of course, answers to these important questions are also uncertain and subject to how markets evolve, but EIA currently projects that every producing region is likely to benefit from a potential recovery. 

Based on its recent infrastructure increases, the Permian basin in particular appears well positioned to participate in a recovery, both for oil and natural gas.

Let’s begin with how global oil consumption is expected to recover along with the economy.

Historically, despite recessions and myriad world events, there’s been a relatively consistent relationship between global economic and oil demand growth, and this relationship has persevered despite segments of the economy that were disrupted this year. 

Along with a rebound in economic activity, EIA expects global oil demand to rise by 6.0 million barrels per day (mb/d) in 2021 (to 99.0 mb/d). Coupled with the natural decline of global oil production, which by International Energy Agency (IEA) estimates generally amounts to as much as 6% per year, global markets may require an additional 4.0 mb/d to 6.0 mb/d of new oil production in addition to meeting prospective demand growth.

If demand recovers along these lines, essentially every barrel of production capacity that was taken off the market this year could be required to meet 2021 demand.  However, restoring production requires capital investments, and industry-wide capital investment recently fell to its lowest levels on modern record, so the industry’s investment cycle could potentially improve in coming quarters. 

Specifically, here’s a comparison of the industry’s quarterly investment flows and the backlog of new capital projects currently under construction.

In API’s compilation of financial reports by nearly 200 companies across the natural gas and oil value chain, industry-wide capital investment in Q3 2020 was less than half of its lowest point during the Great Financial Crisis. Capital investments by firms that focus on upstream resource development fell by more than 60% year on year (y/y) in the third quarter of this year.

Yet, counterbalancing the relatively weak recent flow of investment is an API-estimated $288 billion project backlog – not including upstream resource development – that’s currently under construction. Although some projects could take years to complete, finishing what has been started and creating value for investors requires a continuation of investments in infrastructure that enables the U.S. to increase supply to domestic and access global markets.

The Permian basin is perhaps the best example of a U.S. region that appears prepared to participate in a potential rebound.

For one thing, Permian well productivity rose to record levels in the fourth quarter of this year per EIA and contributed to better estimated breakeven prices – that is, the market price needed to at least pay for drilling a new well – that improved over year-ago levels and recently have been below the spot price of West Texas Intermediate (WTI) crude oil.

Importantly, new Permian pipeline infrastructure should give regional producers the ability to transport oil and natural gas economically to refiners, petrochemical and liquefaction plants, and export terminals across the Gulf Coast.

And even though some pipeline projects have been delayed or canceled through the 2020 COVID-19 recession, the Permian basin’s natural gas and oil pipeline capacity has appeared to be ample for production and could potentially enable large increases.

The ultimate question is how much new and incremental supply the Permian basin might bring in 2021, and EIA’s current projection is that every major oil producing region stands to increase its output next year.

As we said above, it’s been a difficult year, but industry’s increased productivity and ability to expand critical infrastructure has it poised for growth in a broader economic recovery.

That’s American ingenuity by any other name and a reason to have confidence in addition to cautious optimism for 2021 and beyond.