The oil market is arguably the most fickle market in the world…
One day it might set new records for bullishness, the next we might see it plummet into bear-territory. A flurry of global news also makes it difficult to interpret the impact of each development on prices and market sentiment.
Needless to say, it’s critically important to delineate the factors that are moving the oil markets and prices at any particular point in time.
This year, hurricanes, geopolitics, the OPEC deal and U.S. interest rates have all been major factors. Inventory levels and global supply and demand are then influenced by these factors.
This year has been a roller-coaster ride for oil prices. In the first few months, the markets saw huge inventory build-ups crossing the five-year moving average. Then the summer-driving season provided some bullish momentum for oil prices in the shape of inventory withdrawals. A falling rig count and the political crisis in Venezuela added to this momentum, with some analysts forecasting $80 or even $120 oil as a possibility. However, as the summer driving season finished, we saw a return of inventory build-ups.
Hurricane Harvey badly damaged Gulf Coast refineries, affecting almost 25 percent of U.S. refining capacity, driving demand downward and increasing the growing inventory builds. Harvey reduced pipeline capacity, lowering demand and sending oil prices down.
Harvey’s short-term effects proved quite bearish. Hurricanes Irma and Maria soon followed, and there are now reports of a La Niña forming this winter. La Niña, a natural Pacific-cooling phenomenon, can heavily impact weather and increase hurricane likelihood. So there’s a chance of more hurricanes/storms affecting the oil markets in the following months.
Though the Qatar-Saudi standoff is cooling down, the Venezuelan crisis and Kurdish referendum cause concern for oil market analysts.
The Kurdish desire for independence has always been a factor in middle-eastern geopolitics, but the September 25 referendum was a particularly influential event. The price of Brent almost touched $60, with some observers now claiming that the era of “lower for longer” oil prices is over.
The region where the referendum was held also includes the oil-rich area of Kirkuk. If the referendum results in an independent Kurdistan, the state can likely undermine the OPEC production cut deal. An independent Kurdistan also increases the likelihood of a conflict in the area, disrupting oil supplies. Whatever happens, the referendum has the potential to greatly influence oil prices. Erdogan’s tough stance against the referendum and Barzani’s determination to have one has resulted in a standoff unlikely to resolve anytime soon.
Kurdistan is far from the only geopolitical factor in oil markets. Escalation of tensions between the U.S. and North Korea has analysts on edge. North Korea has already fired two missiles that flew over the Japanese island of Hokkaido and fell into the Pacific. Further escalation could corrode the value of dollar, affecting commodities worldwide.
The Iran deal is yet another factor to add into the current geopolitical soup.
Oil prices also gained support when the Paris-based International Energy Agency (IEA) published a bullish report a few weeks ago citing an uptick in global demand from 1.5 million barrels per day to 1.6 million barrels per day. Global supply fell by 720, 000 barrels per day in August, and OPEC output fell by 210,000 bpd, which bodes well for the cartel’s production-cut agreement.
Another factor contributing to the price hike was the news that OPEC members are mulling a decision to extend the current agreement, which is set to expire in March 2018. The members met on September 22 in Vienna to discuss the extension, but were unable to make any progress. There’s still hope, however, that they’ll soon (possibly November) reach an agreement to extend the deal.
Time and again, OPEC has stressed that it’s winning the battle against the supply glut, despite the fundamentals suggesting that’s not the case. According to a survey by S&P Global Platts, OPEC’s “output is still 630,000 barrels above stated ceiling”. The fall in Libyan production was offset by a rise in Nigerian production.
Another key factor for oil prices: U.S. interest rates. Although inflation is currently under control, Janet Yellen signaled that we might see another interest rate hike this year and 3 more next year. In such a high interest rate environment, shale production could suffer, as it will be difficult for investors to borrow money.
Low interest rates have recently provided much stimulus to the shale industry. In 2005, total U.S. E&P debt was $50 billion, which then tripled to $140 billion by 2011. Between 2005 and 2011, borrowing in the shale sector grew by 280 percent. But as interest rates rise, many shale companies might be forced to leave the market—ending the shale boom.
In the coming months, climate change, geopolitics, and interest rates will play a pivotal role in guiding oil prices. The most significant factor, however, will be the OPEC deal. In the short term, oil prices appear to be heading upward, but it would be premature to claim the “lower for longer” era has come to an end.
Oil markets are as fickle as ever, and there are plenty of pitfalls along the road to recovery.