The mercurial nature of the oil market has flipped the mood in the past two weeks from hysterical expectations of severely reduced supply from Iran to concerns over the pace of global economic and oil demand growth.
Trade wars, weakening emerging markets and currencies, and the strengthening U.S. dollar began to overshadow market fears that OPEC leader Saudi Arabia, non-OPEC leader Russia, and their partners in the production cut deal may not be able to offset the loss of Iranian barrels and continuously falling production in Venezuela.
Then the market had to digest the latest geopolitical flare-up with the killing of a Saudi journalist critical of the Kingdom, the international outcry over the incident, and an initial veiled Saudi threat that it could retaliate to any potential sanctions over the death of Jamal Khashoggi.
Saudi Arabia admitted late last week that the journalist was killed in what it described as a “brawl” in the Saudi consulate in Istanbul.
While the market was weighing this development, oil prices were trending down and plunged on Tuesday to a two-month low, with both WTI Crude and Brent Crude slumping by 4 percent—the worst one-day drop since July.
The plunge was the result of several factors.
First, Saudi Energy Minister Khalid al-Falih stepped up rhetoric this week about how reliable Saudi Arabia is as a supplier, how it is ready to meet all customer demand there is, and how the Kingdom won’t weaponize oil and has no intention of repeating the 1973 oil embargo due to the Khashoggi case.
Next, the market has started paying more attention to the demand side of the equation, as concerns creep into the market about an imminent slowdown in global oil demand growth due to the high oil prices and strong dollar that weigh on emerging markets’ oil import bills, and looming global economic growth slowdown amid trade wars and tariffs. Related: Why U.S. Shale May Fall Short Of Expectations
Then, hedge funds and other money managers continued to liquidate long positions and take profits last week, building short positions in Brent and WTI.
The equity sell-off on Tuesday and the American Petroleum Institute (API) reporting a huge build of 9.88 million barrels in U.S. inventories further dampened the mood on the oil market.
Earlier on Tuesday, market participants seemed to buy al-Falih’s latest assertion that “We will meet any demand that materializes” and that OPEC and allies are in a “produce as much you can mode.”
At the Saudi conference dubbed ‘Davos in the Desert’—largely shunned by many because of the Khashoggi case—Saudi Aramco’s CEO Amin Nasser reaffirmed that Saudi Arabia’s 12 million bpd oil capacity “can be sustained for a long time, backed by among the largest reserves in the world, with the highest quality and the lowest cost of production.”
“While geopolitical factors raise the risk that Saudi Arabia backtracks on its supply commitments to offset Iranian sanctions, we do not expect production cuts given the resulting loss of market share to US shale and other oil producers,” JP Morgan said in a note on Monday, as carried by CNBC.
Even before Tuesday’s oil price plunge, money managers, who had already started to liquidate long positions, continued to cut bullish bets last week.
The net long position—the difference between bullish and bearish bets—in WTI dropped 14 percent in the week to October 16, Bloomberg calculations of U.S. Commodity Futures Trading Commission data show. Longs declined 7.1 percent, but shorts surged 38 percent to the highest number since November last year. The net long position in Brent also dropped 14 percent in the week to October 16. Related: The World’s Next Offshore Oil Hotspot
Earlier fears of Iranian supply losses have been slowly turning into fears about the rate of growth in global economy and oil demand going forward, amid unstable emerging markets and currencies, rising dollar, trade wars, and tariffs all weighing on oil demand growth expectations. Rising U.S. inventories have also added to the more bearish sentiment.
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“While the negative impact of rising crude oil prices has yet to affect the 2019 demand outlook, there is no doubt that it will have an impact sooner rather than later,” Ole Hansen, head of commodity strategy at Saxo Bank, wrote in the bank’s recently published Q4 2018 Quarterly Outlook.
While lower supply from Iran and Venezuela and a thinning global spare capacity can be price-positive in the short term, “given the negative impact of the current dollar strength, rising US interest rates and trade wars, we believe that the global economy is not able to cope with runaway oil prices,” Hansen says.
Yet, Hansen notes, Saxo Bank understands the recent bullishness “as the oil market reacts first and asks questions only later.”
By Tsvetana Paraskova for Oilprice.com
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The real reasons behind the recent plunge of oil prices are the receding fears of the impact of US sanctions on Iran’s oil exports and the backtracking by President Trump on his threat to punish Saudi Arabia vis-à-vis the murder of the Saudi journalist which obviated the need for Saudi Arabia to retaliate forcefully by cutting its oil production.
The global oil market took its cue from US Treasury Secretary Steven Mnuchin’s statement two days ago that the United States will allow purchasers of Iranian crude to get US sanctions waivers provided they cut their imports of Iranian crude oil by at least 20%. This is the strongest hint that Mr Mnuchin knows that US sanctions are doomed to fail miserably. That is why the Trump administration has been back tracking from its drastic zero imports to allowing other purchasers of Iranian crude to get US sanctions waivers.
Another pointer is France’s confirmation that the ‘special purpose vehicle’ (SPV) that the European Union (EU) set up to help European companies to do business with Iran while evading US sanctions could also be used more broadly to protect European companies in the future from the effect of illegal US extraterritorial sanctions.
The claim by Saudi Aramco’s CEO Amin Nasser that it would only take 3 months to raise Saudi production to 12 million barrels a day (mbd) implying a spare capacity of 1.3 mbd is a myth. Saudi Arabia couldn’t raise its oil production beyond the 400,000 barrels a day (b/d) that it added to the market two months ago. And even these 400,000 b/d did not come from a rise in production but from stored oil on board oil tankers and on land. And with the failure of the talks between Saudi Arabia and Kuwait to agree to restart the oilfields in the Neutral Zone which is shared equally between them, Saudi Arabia has lost the opportunity to add 250,000 barrels a day (b/d) more to the market on top of the 400,000 b/d it already added two months ago.
And while the escalating trade war between the US and China is creating uncertainty in the markets, it will not dampen China’s oil demand since China’s trade volumes will not be affected, only the destination of its exports might change.
Sooner or later President Trump will realize the futility of his escalating trade war against China. It is a war he can’t win. He will eventually be forced to cut his losses by bringing to an end his trade war with China.
And while the appreciation of the US dollar against currencies of emerging countries could dampen global demand for oil slightly, these countries could overcome this problem by paying for oil imports by barter trade, national currency exchange agreements and the petro-yuan (or gold).
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London