Why The Oil Price Rally May Soon End

Oil forecasters are falling over themselves, publishing new estimates on how high they think prices can go. The rise of Brent to $85 per barrel has forced a rethink among a long line of commodity analysts and investment banks, and the predictions for $100 oil are proliferating.

However, not everyone agrees. Barclays decided to take a contrarian approach, and went against the grain in recent note with its prediction that oil prices will begin to fall before the end of the year. “The recent increase in prices has gone too far, in our view. Although prices may continue to rise from current levels in October, the market is ripe for a correction,” the bank said in a note.

Before that, however, prices could rise in the near-term. But that may only accentuate, or at least bring on, the price correction. “The rally could go even further this month, leading US policymakers, consumers, OPEC, and Saudi Arabia to react,” Barclays said in a note.

There are several reasons why the investment bank says oil prices will fall. First, demand will “soften” at a time when supply should continue to rise. That seems to be the same fear that Saudi officials currently have, at least according to recent press reports. Saudi Arabia is hesitant to increase production now because the oil market will hit a seasonal lull this coming winter, which could take the edge off of the market.

The latest OPEC report suggests that the slowdown in demand due to seasonal factors, combined with rising non-OPEC production, could translate into a decline in the “call on OPEC” by 600,000 bpd in the first half of 2019 relative to August levels.

Saudi Arabia may unilaterally increase production in order to fine-tune the market, hoping to offset Iranian outages, but it did not want to pressure the entire OPEC+ group into increasing output. A formal increase in output may only lead to a situation of oversupply, rising inventories and another downturn in prices, Saudi officials reportedly fear. Related: $200 Billion Saudi Solar Megaproject Might Never Happen

Moreover, it would create a situation where OPEC+ might need to agree to cut production once again at some point next year in response to the glut, and getting more than a dozen oil-producing countries to agree to any change, let alone a production cut, takes a tremendous effort. Thus, OPEC+ did nothing at its latest meeting in Algiers, expecting the market to sort itself out by early next year.

Nevertheless, the market looks rather tight over the next few months. Iran may have already lost about 1 million barrels per day in oil exports, compared to its April peak. News that China may be forced into cutting imports from Iran raises the odds that Iran could lose much more supply in the weeks ahead, forcing oil prices to move even higher as global supplies start to feel the strain.

However, that merely increases the odds of a reaction from the U.S. government. Barclays believes that the Trump administration will either issue more waivers to countries from secondary sanctions, allowing them to continue importing Iranian oil, or absent that, the U.S. could release oil from the strategic petroleum reserve (SPR). “We expect that the White House and State Department will issue significant reduction exemption guidance before the November 4 deadline,” Barclays said. That could include India, Japan and South Korea.

Still, because confrontation with Iran is a high strategic priority for the Trump administration, and maintaining the integrity of the SPR does not seem to garner as much enthusiasm from inside the White House, it would seem that an SPR release is more likely than Iran waivers. Related: $200 Billion Saudi Solar Megaproject Might Never Happen

Another reason why Barclays says that the current oil price rally may be overstretched is that the bank is not as skeptical of OPEC’s spare capacity as some other market watchers. They pointed to the potential restart of the Neutral Zone oil fields on the Saudi-Kuwaiti border, which is often not included in spare capacity estimates thrown around in the press. Those fields could produce as much as 500,000 bpd. Iraq too has ramped up production over the past few months, an increase that few analysts saw coming.

Finally, Barclays says the macroeconomic picture “continues to deteriorate,” with an end to global synchronous growth and turmoil in emerging markets. EM countries face a “one-two punch of weaker currencies and higher oil prices,” the bank wrote. The result could be that oil demand continues to “miss expectations.”

Barclays says oil prices could potentially rise towards $90 per barrel as the November 4 deadline for U.S. sanctions on Iran approaches, but prices decline thereafter. The banks sees Brent crude averaging just $77 per barrel in the fourth quarter, down significantly from the price today. From there, Brent continues to fall, averaging $75 in Q1 2019, $71 in Q2 2019, and just $70 in Q3 2019.

Absent a major supply disruption, Barclays says oil prices will be “anchored” below $80 per barrel.

By Nick Cunningham of Oilprice.com

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