Oil has rallied sharply in recent days to see West Texas Intermediate (WTI) trading at just under $70 per barrel and Brent breaking through the $70 per barrel mark, with crude trading at its highest price since 2014. The surge in oil can be directly attributed to a wide variety of geopolitical risks which are sparking considerable fears that global oil supplies could be sharply constrained in coming months. This has triggered considerable speculation that $100 per barrel is on its way.
According to some pundits, the bearish factors which have weighed on oil prices for some time have been priced in by the market.
Nonetheless, the perception of geopolitical risk and how it is driving oil higher appears to be overbaked and there are a range of threats to the $100 per barrel oil narrative. Key is that U.S. oil production is expanding at a rapid clip. The U.S. EIA recently estimated that domestic production had hit 10,500 barrels daily, its highest level since starting to provide this data in the early 80s. The International Energy Agency (IEA) believes that the U.S. will overtake Russia to become the world’s largest oil producer by 2019.
The big question is whether this along with a marked expansion in the volume of U.S. drilled but uncompleted wells (DUCs) and rig count, which in early April 2018 reached its highest point in three years, is enough to suppress prices. The answer could surprise investors because fundamentals indicate that higher oil is here to stay, for as long as Saudi Arabia and Russia don’t aggressively unwind the production caps established in November 2016.
This is contrary to the thoughts of some analysts including those at Barclays who believe that oil will weaken once again to $51 per barrel during the second-half of 2018. What many analysts who are betting on lower oil are discounting is the effect of stronger global economic growth on the demand for energy. World gross domestic product (GDP) has been forecast by the International Monetary Fund (IMF) for 2018 to expand at 3.9 percent which is 10 basis points higher than the 3.8 percent projected for 2017.
Emerging markets are also surging with many expected to post significant growth in 2017. When those factors coupled with the improved U.S. economic outlook led by Trump’s corporate tax reform are considered it is likely that the global GDP will expand at a greater than the 3.9 percent projected. That will fuel even greater demand growth for oil.
Already, the IEA has revised its 2018 estimates many times. At its last revision in mid-March 2018, the IEA estimated that demand growth would top 1.5 million barrels daily for the year, which is 200,000 barrels higher than its earlier forecast. There is every sign that the global economic upswing which is underway will boost demand even higher.
You only need to consider that in 2017 when global GDP expanded by 3.8 percent, which is 10-bps lower than the 3.9 percent forecast for 2018, global energy demand for the year grew by 2.1 percent or double 2016.
OPEC has forecast demand growth for the year of over 1.6 million barrels daily while the U.S. EIA is predicting that it will be even higher at 1.8 million barrels. The upper end of those later forecasts appears more realistic than the 1.5 million barrels predicted by the IEA.
When you add in growing Middle East tensions, volatile security conditions in Nigeria and Libya, Trump’s push to tear-up the nuclear deal with Iran and Venezuela’s oil industry descending into freefall there is every risk of a significant supply outage being triggered by geopolitical risks. It is likely that with Venezuela’s production deteriorating at a greater clip than has been priced in by markets, this along with Trump pushing to reinstate sanctions against Iran could wipe more than 500,000 barrels daily off global supplies.
That could certainly push Brent to the $80 per barrel mark or higher, which appears to be Saudi Arabia’s desired price.
However, it is questionable whether those unexpected supply constraints working with rising demand growth would be enough to push oil to $100, primarily because the rapid growth in U.S. oil output could meet some of that demand.
What is becoming clear is that a range of supply-side factors including geopolitical threats along with stronger than anticipated economic growth driving greater demand for oil, means that the higher oil narrative has some way to playout. That combined with Saudi Arabia flagging that it intends to continue cooperating with Russia on production caps will prevent global oil markets from tipping into oversupply as some analysts’ claim will occur in late 2018.
By Mathew Smith for Oilprice.com
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