Oil Price could Remain High for Some tTme

Oil Price could Remain High for Some tTme

Oil Price could Remain High for Some tTme

Oil prices rose last week to more than $80 per barrel for the first time since November 2014. Rather than rising on the back of strong demand growth and a positive outlook for the global economy, the recent move in prices has been catalysed by growing market anxiety over supply.

In a reversal of the glut the market endured from 2015 to 2017, there is a real risk we could enter 2019 with not enough oil to go around, setting the stage for oil prices to remain high for some time.

The most immediate source of a supply risk is Iran. US sanctions that directly target Iran’s oil exports will come into effect in early November and estimates of how much oil could be taken off the markets vary from 750,000 barrels per day to as much as 1.5 million barrels per day.

Regardless of the scale of the decline, a sizeable drop from a significant oil exporter will tighten markets in the final months of 2018 and importers will need to scramble to find replacement barrels.

The spectre of sanctions has already led importers to move away from taking cargoes from Iran and recent market surveys point to a drop in Iranian exports of more than 400,000 barrels per day in August alone. The degree of compliance by major importers of Iranian crude already appears to be high, with South Korea, the European Union and India cutting back their purchases sharply in recent months.

The Trump White House is showing no signs of easing the economic pressure on Iran and has so far been reticent to offer waivers on sanctions to importers. Considering the hostile rhetoric traded between the presidents of both the US and Iran at the UN this month, geopolitical risks will continue to exert an upward pull on oil.

While not relaxing the pressure on Iran, President Trump has publicly criticised Opec members several times for not raising production to dampen current prices, including declaring that Opec was “ripping the world off” in front of the UN General Assembly.

Opec members did agree to raise production at their June meeting to compensate for deteriorating production in Venezuela and to put an end to the ‘over-compliance’ with their 2017 production cut agreement with other countries, notably Russia.

But so far the increase has not been large enough to cap prices and Opec countries will be wary of increasing output too much and risk pushing the market back into surplus. Within Opec there are only a few countries that have the capacity to meaningfully raise production, most prominently Saudi Arabia, which has historically claimed an ability to raise production to 12 million barrels per day compared with current levels of around 10.4 million barrels per day. Saudi Arabia has not tested sustained production at that level, however, and there is likely to be a mismatch in terms of the quality of oil it holds in reserve compared with what is actually needed in the market.

While an increase in production now could help to limit the gains in prices it could end up causing more problems further down the road. Opec’s production is currently at around 90 per cent of its total capacity, leaving it little room to adjust production upward to compensate for more unanticipated supply outages or rapid increases in demand.

But it’s not just in Opec where supply risks are exerting upward pressure on prices. In the US the rapid pace of supply growth from shale oil producers is butting up against infrastructure constraints, and Canada is also facing similar takeaway capacity issues.

High oil prices will be welcome news for the GCC’s oil and gas producers as they help shore up fiscal and external balances. But for importers oil prices around $80 per barrel are only another economic headwind to overcome in the midst of rising trade tensions and deteriorating financial conditions in several large emerging markets. One way for oil prices to fall, albeit a gloomier one, would be if disruptions to global trade sank overall commodity demand.

After several years awash in a ‘glut’ of oil, markets need to be prepared to adjust to a sustained period of tightness and endure higher prices. While expectations of oil as high as $100 per barrel are more exclamatory than realistic, sentiment may help push oil prices up from their current levels before we see any downside correction.

Manjula

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