Brent could drop below $40 by early next year

Global demand for crude oil has risen rapidly, as the 50 per cent drop in prices starts to transfer some of the benefit to consumers via lower oil product prices. Global demand is expected to rise 1.5 million barrels/day (b/d) on average in 2015. Fundamentally, oil consumption has recovered across most of the demand engines of the global economy. We expect the total OECD (Organisation for Economic Co-operation and Development) demand to increase around 700,000 b/d. In non-OECD, Indian demand has been very strong this year, up five per cent in the first half. We expect total 2015 oil products' demand to grow 150,000 b/d. Chinese apparent demand has also risen close to five per cent in the first seven months of the year. However, concerns remain over its growth in the near term, with the recent drop in Chinese stock markets, weakening of the yuan and continued slowdown in Chinese electricity consumption painting a bleak picture for the world's largest oil importer. We expect Chinese demand to increase 300,000 b/d in 2015. If the global economy were to get slower, on the back of Chinese slowdown, we could see downward demand revisions for the rest of 2015 and 2016.

India and China have taken the opportunity of low oil prices to either fill strategic petroleum reserves (SPR) and commercial storages, as well as line-fill for their new refineries. For the rest of the year, we expect the demand from SPR filling (in India and China) could be as high as 0.8 million b/d, in addition to domestic consumption in the second half of 2015.

For the year as a whole, non-Organization of the Petroleum Exporting Countries oil output is expected to grow at a yearly average of one million b/d. Although most this has already been observed in the first half of 2015, non-Opec supply growth is expected to get slower in the second half of 2015 but not as much as initially expected. The impact of capex reductions is expected to be felt more during 2016, rather than 2015. Oil producers worldwide have offset a lot of the losses incurred from the drop in oil price by saving from a substantial reduction in oil services costs this year. US oil production growth has stabilised. There is also some slowing of growth in production expected in Brazil, Canada and Russia for the rest of 2015.

If Opec production were to produce at current levels, there would continue to be an excess in the oil markets, leading to stock builds. However, if Opec were to add more capacity, either through planned expansion from Iraq, United Arab Emirates or return of Iranian oil, then we would see this excess close to 1.2-1.7 million b/d for the rest of the year. This is likely to test available onshore storage capacities worldwide, as there are already record high oil and oil products stocks (2.9 billion barrels) in the OECD region. With refineries going offline for seasonal maintenance worldwide at the end of third quarter, we would see pressure building on the front end of the oil price curve.

We expect Brent to average just over $42/barrel in September and around $40/barrel in October to December, before dropping below $40/barrel early next year. Given the amount glut in the markets, continued resilience shown by US oil producers and Opec market share strategy, we could see oil prices taking longer than 2008-09 to recover. We expect the WTI discount to Brent to be around $4-6/barrel, with spreads widening to $6/barrel towards the year-end due to Cushing filling up.

The author is lead oil markets analyst, Natixis Commodities Research, London