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Nick Cunningham

Nick Cunningham

Nick Cunningham is an independent journalist, covering oil and gas, energy and environmental policy, and international politics. He is based in Portland, Oregon. 

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The Oil Price Risk Analysts Are Ignoring

Oil prices have given up some of the gains from last week’s oil tanker attack in the Gulf of Oman, with recession fears outweighing geopolitical tension and the risk of supply outages.

“The response of oil prices to the latest escalation in the Middle East has been comparatively subdued given that 30% of global oil shipments pass through the Strait of Hormuz and only a small proportion of this total could be rerouted through pipelines in the event of a conflict,” Commerzbank wrote in a note.

Tensions between the U.S. and Iran continue to rise with American officials stating that a military option remains on the table. On Monday, Iran said that it would step up enrichment of uranium and may breach the limits laid out in the 2015 nuclear deal in response to American sanctions.

The possibility of another catastrophic war in the Middle East is at its highest in recent memory, but the oil markets are largely shrugging off the risk, instead training their sights on the deteriorating economy. Nearly half of CFOs surveyed by Duke University and CFO Global Business Outlook see a recession by mid-2020.

With pessimism setting in, oil has barely budged, despite the spike in U.S.-Iran tensions.

Hedge funds and other money managers stepped up short bets on WTI by 46 percent for the week ending on June 11, according to Bloomberg and CFTC data. Traders are clearly betting on a souring economy. “Outside the United States it’s unmistakable world growth is slowing down,” Bill O’Grady, chief market strategist at Confluence Investment Management LLC, told Bloomberg. “The more trade tensions arise, the greater the likelihood that growth is slow, and if Chinese growth slows, it’s not good for oil.” Related: Oil Flat Despite Middle East Tensions

In a new report, Bank of America Merrill Lynch lowered its oil demand growth forecast to just 0.93 million barrels per day (mb/d) this year and 1 mb/d in 2020. “Yet there is a risk we end up being too optimistic if the US-China trade relationship deteriorates further. Additional tariffs would likely force us to revise our numbers lower,” analysts at Bank of America wrote. The investment bank lowered its pricing forecast for WTI and Brent for the second half of 2019 to $56 and $63 per barrel, respectively, down from $58 and $68. The downdraft extends into 2020 with Bank of America predicting Brent to average just $60 per barrel and WTI $54 per barrel.

“The reason oil prices are going down is because there’s plenty of oil, and that’s also true with a lot of commodities,” Tim Rudderow, who manages $1.5 billion at Mount Lucas Management LP, told the Wall Street Journal. “There’s not a shortage of anything.”

The market is downbeat, but an even deeper slide is possible. Bank of America Merrill Lynch put it this way: “If Xi avoids G20 and buys Iranian barrels, oil goes to $40.” In this scenario, Chinese President Xi Jingping digs in and resists American pressure on tariffs, which leads to another wave of U.S. tariffs on Chinese imports. That drags down the global economy, thus sinking oil demand. Meanwhile, Xi may also decide to continue to buy oil from Iran, resisting American pressure on sanctions. In that scenario, Iran’s oil exports fall by less than expected. The end result is an oversupplied market and oil prices crashing below $40.

Barring this extreme scenario, Bank of America said that there are a few factors that could help oil markets rebound. First, the bank expects the U.S. Federal Reserve to slash interest rates three times over the next 12 months. Then, of course, OPEC+ will extend the production cuts, helping to keep surplus oil off of the market. Finally, the Trump administration could back down from its trade war with China in the wake of a global economy hitting the skids. Related: The “Polar Silk Road” Could Be A Gamechanger For Natural Gas

The first two factors – OPEC+ cuts and a dovish turn by the Fed – seem reasonably likely. But Trump’s trade war with China shows no signs of slowing down, despite the raft of bearish news. In comments over the weekend, U.S. Commerce Secretary Wilbur Ross seemed to lower expectations of a breakthrough with China.

“I think the most that will come out of the G-20 might be an agreement to actively resume talks,” Mr. Ross said in a WSJ interview Sunday. “At the presidential level they’re not going to talk about the details of how do you enforce a trade agreement.”

“The most that might come is new ground rules for discussion and some sort of schedule for when detailed technical talks might resume,” Ross added.

By Nick Cunningham of Oilprice.com

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  • Brian Bresee on June 17 2019 said:
    There is an old saying, "Cash is King", and that will play out on the world stage in the trade war with China. Just look at the trade imbalance to see who has the cash. Only a propagandist in China believes China is the only place with cheap labor to build things is found, and doubt not there is plenty of cash to buy cheap products out there. Instead of a product being built in China, it will now be built in Vietnam, or better yet Mexico or South America. Oil demand will now increase in South America instead of China, balancing world demand out in timely fashion. The only difference is WTI produced oil is closer to Mexico/South America, making its demand increase, especially across the border with Mexico. The added bonus for the US to this scenario is it will also reduce economic pressure for South Americans wanting to immigrate to the United States, with the quality of life improving in their own country. China will no longer have a market to sell their stuff built from stolen intellectual property, finding themselves slowing sliding back into third world status.

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