Recent Trends In The Oil Market

The global oil market is going through a period of inevitable change and the industry faces a particularly challenging set of obstacles, ranging from the pressure of environmentalists to increasing geopolitical factors. While many oil producing countries are constrained by sanctions by the US administration, the shale gas industry in the US is increasingly leading the expansion in global oil supplies. The industry also has to face a volatile oil price, a wide talent gap, and an unrelenting image issue, which will have critical implications for energy security and market balances and will contribute to a transformation of global oil supplies.

The industry had recovered from the slump seen in 2014 when the oil prices touched all-time lows. The prices have improved from the $40, 2016 annual average WTI price low and lately Brent Crude has averaged between $60 to $70, providing support to many companies. This sustained recovery has been due to many factors, including less oil coming to market from challenged producers and production agreement made by the OPEC and non-OPEC members to restrain oil output and prevent an inventory glut. Shale gas producers have also become less aggressive and seem to show a conciliatory tone, recognising the financial burden felt during the slowdown in the industry.

Lately, the oil market has gone through a sentimental upheaval due to the simmering tension between Iran and the Western governments, especially the US. The conflict started when the US government repealed the nuclear deal it had signed with the Iranian government, with the support of other world powers, and imposed sanctions on the country. Tensions grew when Iranian armed forces who shot down an American drone and were allegedly behind sabotage attacks on six tankers in the Gulf in May and June. Iran responded to unilateral withdrawal from the nuclear agreement by breaching the nuclear deal by exceeding uranium limit set by the agreement.

However, in a move pertinent to the oil industry, it has also threatened to disrupt the flow of traffic through the Strait of Hormuz, the vital Gulf waterway which is considered the world’s most important oil transit chokepoint. Last year, about a third of global liquefied natural gas trade, along with about 21 per cent of world petroleum liquids consumption, was shipped through the strait, indicating the high importance of the channel. Even during the Iran-Iraq conflicts, the gateway was left untouched, signalling the importance of its importance to the Middle East countries. Moreover, Asian countries are more exposed to it as about 65 per cent of all the crude and condensate passing through the Strait of Hormuz goes to China, India, Japan, South Korea and Singapore, and the principal exporters that use it are Saudi Arabia, Iraq, Kuwait, the United Arab Emirates and Iran, all the major oil producers.

The growth in the world economy will essentially drive the demand of oil, but many experts forecast that the growth will come under serious strain in the upcoming months, not at least due to the US-China trade war. According to the latest Monthly Oil Market Report by OPEC, economic growth is poised to remain at 3.2% in 2019 and 2020, assuming that trade-related issues do not escalate further. Economic growth faces downside risk from protectionist policies followed by many countries, which has resulted in the trade war. A continuation in the current slowdown in manufacturing activity, limitations in fiscal and monetary space, and deteriorating consumption pose a threat to growth. As a result, world oil demand growth forecast in 2019 was cut by 150,000 barrels per day to 1.07 million barrels per day by the US Energy Information Administration, citing weakening economic growth and lower-than-expected global fuel consumption. The report by OPEC also noted that the demand for OPEC crude for 2020, projected to be 1.3 million barrels per day, lower than the 2019 level of 29.3 million barrels per day, which can potentially destabilise build-up in oil inventories.

Although, the United States had the largest increase in global demand in 2018, in late 2018, it also became the largest crude oil producer in the world, surpassing Russia and Saudi Arabia, thanks to the incredible strength of its shale industry. Possibly triggering a rapid transformation of global oil markets, experts reckon that it will lead to oil-supply growth over the next six years, which would considerably alter the energy geopolitics of the world. According to the US government’s Energy Information Administration, its net imports of the commodity is poised to average just 3 per cent of total consumption this year.

However, the picture is not as rosy as it seems, as though the US President Donald Trump might boast about the energy independence initially pursued by presidents since Richard Nixon, the refining industry in the country is generally designed to process heavier crudes, not the lighter ones produced in the shale oilfields nearby. Therefore, rather than trying to process shale oil in domestic refineries that are not configured to process it, the producers find it more economical to bring heavier crude all the way from Saudi Arabia, resulting in simultaneous import and export of the commodity. Though, the US has less macroeconomic exposure to a surge in crude prices, it is still exposed to what happens in global oil markets, which is further exacerbated by the concerns about the financial health of the US shale industry.

Recently, OPEC and its allies, which includes Russia, agreed to further support the oil prices by extending production cuts for at least another six months, indicating that the cartel is stuck in a cycle it cannot get out of. The oil prices around the world rose on the news, though Iran did not seem very happy with the unilateral decision by Saudi Arabia and Russia. Production would be cut by on 1.2m barrels a day of output to help prop up the oil price which had been battered by upsetting economic news. Despite endless rounds of production cuts, the cartel has not been able to support oil prices significantly as the expansion of the US shale industry has moved out of the efforts of the group. Moreover, the share of the cartel in the global oil market has slipped to the lowest in almost three decades, which was worsened by US sanctions against OPEC members, Iran and Venezuela. Though, Saudi Arabia has benefited from US sanctions, the kingdom is increasingly reliant on further supply disruptions to support the oil price, straining its fiscal calculations.

Trade and refining will face profound consequences as the demand for oil in future would be driven by Asia, fastened by the ongoing shift of growth away from developed economies. These countries would have to increasingly look out for energy security, as highlighted by the recent conflict between US-Iran, where President Trump has asked Asian countries to pitch in more towards the security of oil routes. The sector will also have to adapt to the new rules governing bunker fuel quality by the International Maritime Organisation. This will take effect in 2020 and there have been fears of shortfalls when the rules come into effect, as market experts fear industry players are ill-equipped to deal with the change, despite having had several years notice.

As there seems to be more focus on demonstrating returns rather than investing for new growth, companies remain cautious and upstream capital expenditures have not yet recovered commensurately with prices in 2018. There has been increasing pressure on the industry to comply with global norms of climate prevention, and companies have been looking for an alternative to the oil industry. The Left-forces in the developed world has been asking the industry to do more to prevent massive carbon emission the industry is infamous for. However, as no feasible alternatives exist for vital petroleum products, the industry is not going anywhere anytime soon, but it needs to continuously change for sustainable development.

If we look at the current oil scenario, the market is stuck between the risk of a slowdown in economic growth and tensions between the US and Iran. Also, the Druzhba pipeline to Europe was affected by the discovery of contaminated Urals crude which resulted in Russian oil output falling close to a three-year low in early July, providing a short-term support to the market. Even as the EIA raised its outlook for US crude oil production to an all-time high of 12.36 million barrels per day in 2019, markets also gained support from forecasts that US crude stockpiles fell 3.1 million barrels in the first week of July. Moreover, Tropical Storm Barry is heading towards the Louisiana coast and offshore oil production, refineries and transportation may be impacted for days or even weeks to come as operators evacuate personnel or move rigs out of the path of the storm. By July 12, 2019, 1.1 million barrels per day had been halted, contributing slightly to rising oil prices.

Price Commentary

Daily Chart as at July-16-19, before the market closed (Source: Thomson Reuters)Â

On 16 July 2019, at the time of writing (before the market closed, GMT 3:31 pm), Brent Crude prices were trading at $66.81, up by 0.51% against the previous day closing price. The 52 weeks High and Low price is $86.74/$49.93, with an average price of $68.74.