As 2018 winds down, we can expect the oil market rollercoaster to continue its wild ride into the year ahead. And wild it has been. West Texas Intermediate (WTI) crude prices rose close to 30% between January and October, from $60/bbl to $78/bbl, only to crash to multi-year lows this December. WTI futures are now trading under $45 whereas Brent crude – the global benchmark – is now trading in the $50-60/bbl range. What’s more, day-to-day oil prices are fluctuating as much as 5%, reflecting an unprecedented level of volatility in the marketplace.
The supply of the product based on projects funded years earlier, the demand based on economic performance, and geopolitical factors all define oil prices. The question is whether the economic, technological, and geopolitical fundamentals behind these price trends are likely to shift dramatically over the next 12 months. In other words, should we expect more of the same in 2019?
Let’s look at the factors currently at play:
For starters there is a crude supply glut, with global producers led by the “Big Three” — The United States, Russia, and Saudi Arabia – pumping about 1.5 million barrels more than consumers need at current prices.
The United States, powered by the massive Shale Revolution, is now the largest crude oil producer in the world, surpassing Russia and Saudi Arabia with its 11.4 million barrels of production per day. Majors like Exxon Mobile (NYSE:XOM), Chevron (NYSE:CVX), and Royal Dutch Shell (NYSE:RDSA) have now joined Shale operators like EOG Resources (NYSE:EOG) and Pioneer Natural Resources (NYSE:PXD) to increase U.S. supplies by 2 million bbl/d since 2017.
In November the United States actually exported more crude oil and refined products than it purchased, granting it net energy exporter status for the first time since 1991.
Advances in exploration and production (E&P) technology – particularly in Big Data, machine learning, and automation – have led to tremendous efficiency gains and lower break-even prices for American producers, especially in the shale space. Output has surged to such a level that in areas like the Permian Basin, where a massive new discovery was just announced, there simply isn't enough pipeline capacity to move it all. The role of America’s energy resurgence in the state of today’s markets cannot be overstated.
OPEC+, the reimagined OPEC super-cartel which accounts for 55% of global oil production, has had a difficulty in meeting its responsibilities as the ‘market-stabilizer.’ Saudi Arabia in particular, the global swing producer, did not succeed in implementing a cut necessary to keep oil around $70/barrel.
Most of OPEC’s members benefit from a steady market price in the $70 - $90/bbl price range: high enough to cover national fiscal obligations but not so high as too spur investment in competing fuel sources and technologies, especially renewables and electric cars. But over the past year, Iran sanctions, Venezuela’s economic implosion, and Qatar’s sudden exit from OPEC have all served to undermine the cartel’s price-setting ability.
OPEC did eventually agree to a 1.2 million bbl/d cut earlier this month in Vienna, but it remains to be seen whether a) all parties adhere to the cuts without cheating and b) the cut is substantial enough to counter-act larger macroeconomic forces at play.
An oversupplied market is exacerbated by slowing growth and near–panic of a global recession. China and India's increasing crude imports have not been enough offset the dropping consumption among other emerging economies. Market contagion is spreading, putting a defacto lid on non-OECD demand and applying yet more downward pressure on prices.
Interest rate hikes from the U.S. Federal Reserve have also accelerated the oil price drop. Higher rates make the dollar more expensive. Since oil is priced in dollars, a stronger greenback hurts international demand for crude – especially as certain economies experience devaluations of their currencies. And higher interest rates could slow economic activity: borrowing becomes more expensive and debt becomes costlier to service. This could lead to further slowdowns in the global economy, undercutting crude oil demand.
If fears of a recession materialize, we should expect trends to continue on their current downward trajectory. And that’s the direction macroeconomic indicators are pointing. Growth in the OECD is projected to shrink 0.1% next year, whereas the world as a whole should see a 0.2% drop through 2019 from 3.7% to 3.5%.
Even with the impending OPEC+ production cut (less than 2% of global supply) the only factor I see influencing prices in a meaningful way is geopolitical turmoil. And we may have our fair share of that in 2019. President Trump's intent to withdraw all 2,000 U.S. troops from Syria and 7,000 from Afghanistan will have serious implications for security and stability in the region. The resulting power vacuum will lead to increased assertiveness from trouble-makers in the region (Russia, Iran,), and could even result in an Israel-Iran-Syria war. This would undoubtedly send oil prices skyrocketing, particularly if Iran follows through with its threats to blockade the critical Strait of Hormuz.
Thus, 2019 oil markets should look a great deal like those of 2018: Volatile, cyclical, and unpredictable, with a downward trend if the global recession hits. Happy New Year!
James C. Grant, Program Manager at International Market Analysis Ltd., contributed to this article
