Despite the crisis in Venezuela, which could shut in a lot more oil supply, global crude prices have been mostly flat for two weeks. Oil traders have weighed prospect of serious outages in Libya, Iran and Venezuela against the unfolding slowdown in the global economy.
The tepid price movements over the last two weeks is rather surprising, given the tightening of supply. The OPEC+ cuts are taking effect, and U.S. data is starting to reflect these changing market conditions. “The weekly report from the EIA on U.S. oil stocks was bullish for outright prices, plain and simple,” Tamas Varga, an analyst at PVM Oil Associates Ltd. in London, told Bloomberg. However, “more hard work is needed to turn this market unreservedly bullish.”
Ultimately, the cracks in the global economy will outweigh the tightness on supply-side factors. Global growth has started to slow. Chinese factory data has shown signs of contraction. The U.S. Federal Reserve was even forced to back off further interest rate hikes in recognition of weak economic growth globally. “The case for raising rates has weakened somewhat,” Fed Chairman Jerome Powell said in late January.
The fragile state of growth puts outsized importance on the U.S.-China trade talks. The trade war was put on pause in late 2018, but the March 1 deadline is rapidly approaching. Without a comprehensive deal on a range of trade issues, the Trump administration has threatened to increase tariffs on $200 billion worth of Chinese goods from 10 to 25 percent. With the Chinese economy already faltering, such a move could be decisive in how the global economic picture shapes up in 2019. Related: Oil And Gas In Spotlight At State Of The Union
The good news is that both sides seem eager to make a deal. The pause in the trade fight alone was a sign that tariffs were hurting both economies.
Next week, U.S.-China trade talks resume and President Trump is sending U.S. Trade Representative Robert Lighthizer and Secretary of Treasury Steven Mnuchin, a high level delegation that suggests the U.S. wants to make a push for a major deal. The Wall Street Journal reports that President Trump demurred on whether or not he would meet Chinese President Xi Jinping – if they were to meet, that would send a signal that a trade deal is within reach.
But they are clearly making progress. And the pressure is greater than it has been in the past. From the U.S. side, Trump’s poll numbers have taken a dive recently, he lost control of the House of Representatives in November, and the 2020 presidential election is just around the corner. Farm country has been hit hard by Trump’s trade war. He can ill-afford to keep this trade fight up for much longer.
China, too, is under pressure. Last year, China’s GDP grew at its slowest pace in decades. In January, China’s manufacturing activity contracted for the second consecutive month, a worrying sign of an unfolding slowdown. The Chinese government has been trying to roll out stimulus, but so far those efforts have not meaningfully altered the trajectory. “On the whole, countercyclical economic policy hasn’t had a significant effect,” Zhengsheng Zhong, director of macroeconomic analysis at CEBM Group, said in late January.
In other words, with the pressure ratcheting up, both Trump and Xi should be amenable to a deal. The WSJ reports that China has already made some concessions, agreeing to discuss previously off-limits subjects such as hacking of U.S. companies. It would not be surprising, too, if the Trump administration made some concessions, secured a watered-down deal, declared victory and went home.
That is not a given, however. With U.S. Trade Representative Robert Lighthizer, a China “hawk,” leading the talks, the U.S. still could maintain a tough line. And with China on the back foot, the Trump administration may think they have the upper hand, allowing them to dig in. Related: Bank Of America: Oil Demand Growth To Hit Zero Within A Decade
To a very large degree, the outcome of these negotiations could have a cascading effect on the oil market this year. As John Kemp of Reuters puts it, the March 2 deadline for the trade talks is “the most important date in the calendar for oil traders,” potentially having a more important impact than the OPEC+ meeting or even U.S. sanctions on Iran.
Not only that, but whichever way the trade talks go, they will inform the next steps for other events. A breakthrough in trade talks could conceivably lead to higher levels of oil demand since it would be interpreted as a positive for the global economy. That would increase the odds that OPEC+ could ease its production cuts at an earlier date, while also leaving less room for the White House to tighten the screws on Iran.
An impasse, and an increase in tariffs, could tip the global economy into recession, forcing OPEC+ to extend its cuts, although it would leave much more room to take a harder line on Iran. Such an outcome on the trade issue would be hugely negative for oil prices.
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The next round of negotiations will take place in Beijing next week.
By Nick Cunningham of Oilprice.com
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Still, there are strong indications that both the United States and China are keen on reaching a quick settlement of the trade war between them. President Trump has at last realized that the trade war was hurting the US economy far more than China’s since the Chinese economy is bigger and far more integrated in the global trade system than the United States’. Moreover, US negotiators are well advised not to try to twist China’s arm during the next round of negotiations because China will never put its name to any agreement which will enable President Trump to claim victory.
And while the uncertainty in the global economy has had some effect of decelerating the global demand for oil, it hasn’t actually affected China’s insatiable thirst for oil imports which hit 10.43 million barrels a day (mbd) in 2018 and are projected to reach 11 mbd this year. This is not a sign of a slowing down Chinese economy.
The reason the global oil market was unmoved by US sanctions on Venezuela is that Venezuela’s exports of 500,000 barrels a day (b/d) to the US can be redirected to China, India and the European Union (EU). So there will be no loss of supply in the oil market. Moreover, the US could easily replace the loss of Venezuelan oil exports by imports of Canadian heavy oil which are the most accessible alternatives to Venezuelan crude for Gulf Coast refiners.
Furthermore, these sanctions will hardly impact on the global oil market and prices unless there is a complete collapse of Venezuela’s oil industry as a result of a general strike by workers of the National Oil Company of Venezuela, PDVSA, or a civil war.
And in case Venezuela’s oil production collapsed, the Trump administration can’t bank on Saudi Arabia making up for any shortfall. Contrary to claims otherwise, Saudi Arabia has neither the spare capacity nor the inclination to make up for any shortfall. Saudi Arabia made a serious mistake in June last year when it agreed under intense pressure from President Trump to jointly add with Russia 650,000 barrels a day (b/d) to an already existing glut in the market causing oil prices to slump by 43% and inflicting losses on its economy and the economies of OPEC members. Saudi Arabia may decide this time to shun any request from President Trump to raise production in anticipation of something that may or may not happen.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London