Oil prices collapsed at the start of this week, with WTI and Brent dropping 5.5 percent and 7.5 percent respectively from their three and a half year peaks.
This recent price slump serves as a timely reminder for market observers and players alike that, while a heightened geopolitical risk premium and declining inventories have boosted prices, there is plenty of downside in today’s markets.
The prices started to fall when Saudi Arabia and Russia, two key brokers in the Vienna agreement, announced that they are ready to ramp up production to counter the threat of falling supply from Iran and Venezuela. The fear of a huge surge in U.S. shale production also played a part in sending oil prices lower, with rising U.S. exports to Asia beginning to impact the market share of both Russia and Saudi Arabia in the region.
Many already understand that this price rally is not sustainable. Vladimir Putin recently said that an oil price of $60 “suits Russia”. Last year, Russia’s finance minister shared his plans to draft the 2017-2019 budget based on oil prices as low as $40. These statements, taken alongside the recent reports that Russia and Saudi Arabia are looking to bring some production back online, have been seen by some as a sign that the recent oil price rally is coming to an end. It has long been known that these kind of production deals are not long term and sustainable solutions to an oil market crisis.
This is not to say that oil prices can’t rise again, or even touch $100 in the near future. Both the Iran nuclear deal and collapsing production in Venezuela could provide plenty of upside to oil prices. Tensions between Israel and Palestine are adding to geopolitical tensions in the Middle East, with Israeli military forces having launched an attack on Palestinian positions in Gaza after rockets were fired from the Gaza strip. The war in Yemen, instability in Libya and the recent Iraqi elections all represent further flashpoints for oil markets in the region.
Away from geopolitical risk however, there is an important lesson to be learned from the influence that the recent comments from Saudi Arabia and Russia had on oil markets. The production cut will not go on forever, and the oil market cannot sustain current prices when OPEC and its partners return to normal production levels. The market requires a continued rise in demand from emerging economies and a pullback in shale production if it is going to maintain higher oil prices once the OPEC deal does comes to an end. An analysis from CNBC follows this logic and comes to the conclusion that WTI might fall to $55.
Analysts and actors in today’s oil market should tread with care, the gains that have been seen in the last year are by no means locked in and, while prices can undoubtedly go higher, the ‘new normal’ for oil prices is yet to be determined.
By Osama Rizvi for Oilprice.com
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