Agri Business

Crude oil slips on unsteady demand, weak dollar

G Chandrashekhar September 3 | Updated on September 03, 2020

The global crude oil market is at a crossroad. While the tug-of-war between just adequate supply and gradually rising demand is palpable, the ultra-loose monetary policy of various central bankers, especially the US Federal Reserve, is seen skewering the market at present.

The massive demand destruction witnessed in the early stages of national lockdowns and disruption to global supply chains, in the last three months, has given way to increased consumption as nations ease travel and other restrictions. Economic activities are rapidly improving in many countries, especially in China.

While it may take at least one more quarter, if not more, for economic activities worldwide to pick up further momentum, the signs are ominous.

Banking on vaccine

As hopes of vaccine availability soar, economies are lifting restrictions and opening up. Since July, consumption demand has been rising steadily under the lead of China.

At the same time, supply from the OPEC+ group is fairly disciplined as producers have implemented strict output cuts. Earlier expectation that the agreement may fall apart even if partially has been belied. Strict compliance has ensured sustained price rise since April and a sense of equilibrium in the market.

Large non-OPEC producers such as the US have not been able to raise output to take advantage of the current attractive price levels. Rig count in the US has fallen to multi-year lows. Current prices ought to encourage drilling companies to return to production; but high levels of debt are discouraging resumption of drilling activity.

Weak dollar

The economic conditions in many emerging markets, including India, are grim as infections soar around the world. This is a cause for concern; and if not contained soon, demand can take a hit.

While supply and demand fundamentals are playing a ‘cat and mouse’ game, ultra-accommodative monetary policy of many central bankers and fiscal stimulus is adding to liquidity. The US dollar has depreciated significantly as a result; and as is well known, a weaker dollar pushes higher the price of commodities quoted in that currency. Last week, the US Fed announced what can be called a flexible form of inflation targeting which suggests that the extant easy money policy will continue for a longer period. This is sure to prove to be a drag on the value of the dollar although the currency is showing signs of firming at the moment.

If massive funds are available at dirt-cheap rates then liquidity-driven commodity boom will continue for a longer period, and market fundamentals will take a backseat.

There is another aspect to the crude oil market related to the enormous losses that producing countries incur as a result of voluntary output cuts. Revenues of producing countries are plunging. For how long will the countries be able to sustain losses, given the social obligation of various governments, is something to ponder over.

But herein lies a dilemma. Higher production would bring energy prices down with concomitant impact on revenue, especially in the context of weak demand growth outlook. This would suggest that oil prices are unlikely to sharply rise from the current levels.

After chalking up gains for five straight weeks, Brent is currently trading at $44-45 a barrel while West Texas Intermediate (WTI) is some $3 lower. On current reckoning, by the end of the year, crude oil prices are unlikely to be significantly different from these levels.

(The writer is a policy commentator and commodities market specialist. Views are personal)

Published on September 03, 2020

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