Global Economic Trends Diverge Further
Global economic growth concerns resurfaced during the month of September, as data from the Euro-zone suggested that select large counties yet again face recession. Even Germany, the bulwark that shielded the common currency area during the fiscal crisis, has slowed down as subdued external demand has taken a toll on exports. The Euro-zone also faces deflationary risks as the struggling labor markets and absence of meaningful fiscal stimulus measures have kept domestic demand soft. In Japan, the central bank has lowered its growth and inflation estimates for the current year as well as for 2015. In contrast, though select indicators such as retail sales and durable goods orders were below expectations, the U.S. economy continues to expand at a healthy pace.
Equity and credit markets saw increased volatility during September as investors are concerned about a further slowdown when the U.S. Federal Reserve ends its bond purchases. Though the European Central Bank and the Bank of Japan have indicated the possibility of expanding their quantitative easing programs, neither have announced a clear plan yet. Global manufacturing activity expanded at a slower pace in September, restricted by the Euro-zone where output increased only marginally. New orders declined for the first time in more than a year, suggesting growing caution among businesses about near-term demand. The major emerging markets, except Brazil, Russia and South Africa, continued to see gains in manufacturing output, though the pace declined from the previous month. Exports from Asia, including China and Korea, were mostly stronger than expected during September, but could be more subdued during the current quarter as shipments to meet holiday season demand are completed.
GLOBAL INDUSTRY SPOTLIGHT FOR THE MONTH: ENERGY
The sharp fall in oil prices since the beginning of September has clouded the earnings outlook for oil explorers and producers. Increased U.S. domestic production has kept the market well supplied while slower economic growth in Europe and select emerging countries have restricted demand growth. Lower prices are likely to discourage new investments in both upstream as well as downstream facilities, which would likely hurt equipment suppliers and oil field services providers. However, some of the recent supply sources could become commercially unviable at lower prices and this could potentially create a price floor for crude oil.
Despite the erratic global economic trends, international oil prices have been fairly stable in recent years. Though prices never regained the pre-crisis highs, the Brent benchmark traded between $100 / barrel and $120 / barrel since 2011, until it slipped last month. Despite rising U.S. oil production, heightened geopolitical risks in the Middle East and Eastern Europe have kept prices elevated. In addition, demand growth was expected to sustain a modest pace in the coming years. This price range was remunerative enough for most producers and their earnings growth was healthy during this period, except for the select few that faced output declines or penalties related to environmental damages.
The subdued economic trends in the Euro-zone and select emerging markets have led to downward revisions in global energy demand forecasts. The International Energy Agency (IEA) now expects average daily global demand for 2014 to touch 92.4 million barrels, 0.2 million barrels lower than its earlier estimate. This is expected to rise by a moderate 1.1 million barrels per day in 2015, if current economic growth forecasts hold good. If global economic growth turns more subdued, energy demand is likely to fall short of even this lowered estimate.
At the same time, global energy output is set to rise in the coming months. Aggregate U.S. crude oil output averaged 8.7 million barrels a day in September, compared to the 7.4 million barrel average for 2013, according to the U.S. Energy Information Administration (EIA). The EIA expects output to increase to 9.5 million barrels a day in 2015. This growth in U.S. production has effected significant changes in international crude oil trade. For instance Nigeria, once one of the major suppliers of crude oil to the U.S., has almost stopped U.S. shipments this year and is instead diverting supplies to Asia. U.S. imports from OPEC, the group of oil producing countries, have declined by nearly half since 2008. This realignment in oil trade has added to the downward pressure on prices.
The IEA’s medium-term production outlook suggests that supply is set to increase in the coming years, across all major producing countries. If the current momentum is sustained, U.S. output is forecast to increase to nearly 13 million barrels a day by 2019. Saudi Arabia and Russia, two of the largest exporters, are also likely to see modest gains. Brazil is likely to see a more than 50 percent increase in output during this period to over 3 million barrels a day, according to the IEA. As well, Iraq and other countries in the Middle East are likely to see gains, though production estimates for these countries may not be as reliable given the volatile environment. The North Sea is among the few major producing regions that is likely to see a fall in output.
Though the price of oil has declined, the cost of finding new reserves and setting up new production facilities remains high. In recent years, an increasingly large share of investments in global energy has gone into non-conventional sources such as shale and oil sands. These sources, while increasingly accessible with modern technology, are not cost-effective when compared to conventional reserves. Many of the non-conventional projects become unviable at prices close to $80 / barrel, and most global energy companies have indicated that they are restricting new investments. This trend is likely to gather pace in the coming months, as explorers and producers are likely to be cautious even if oil prices see a modest recovery. As a result, the revenue growth outlook for suppliers of drilling and other equipment, as well as oil field services providers is likely to remain subdued.
Nevertheless, lower investments could limit the growth in supplies in the coming years to below current forecasts. Some producers, such as those operating in U.S. shale oil and Canadian oil sands, could even reduce current production. In that scenario, and also if the global economy gathers pace, energy prices could rebound to the range seen in recent years.
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