It’s imperative to manage oil price risks

G Chandrashekhar | Updated on February 07, 2019 Published on February 07, 2019

The crude oil market has been groping for direction since the beginning of the year. There is no fresh market moving trigger to influence price direction. The market is currently seen to be in consolidation mode in the vicinity of $60 a barrel for Brent.

Could Venezuela provide the trigger? Last week, the US imposed sanctions against the Venezuelan oil sector. It is clear that sanctions mean oil shipments from the producing country will decline in the near future; and unlike the case of Iran where some exemptions have been granted, countries will be reluctant to purchase oil from Venezuela. Europe, in particular, is with the US on this issue. Russia’s stand will be watched closely, as also China’s.

In other words, the market is likely to lose supplies of about one million barrels a day from this origin; and certainly half of that was in any case going to the US. Decline in availability to the extent of a million barrels a day is sure to disturb the fairly balanced supply-demand fundamentals. This has the potential to attract speculative capital into this market, which, in turn, will exert an exaggerated impact on prices.

Yesterday, once more?

The one remedy against this outage that is widely anticipated is that OPEC will have to rise to the occasion and step up production. But remember, it was in the early months of last year that the market witnessed a decline in Venezuelan production; and yet, OPEC did not raise output almost until June, a few months later, as a result of which the market tightened. We all know how prices reacted. Is the situation different this time?

With the agreed production cuts kicking in and output declines reported from Iran and Libya, January saw a certain firmness in prices. In the US, drilling activity has been falling in recent weeks. It is reported that as of February 1, the number of oil rigs has fallen by 15 from the previous week to 847, the lowest in eight months. It also means slower growth in US shale oil production.

With so much happening on the supply side, the focus on demand has been deflected. However, those with a medium-term view foresee a loss of global growth momentum ahead. With prospects in Europe and Japan already tepid, and China slowing, there are unmistakable concerns about global growth in 2019.

Crude oil fuels economic growth. Any undue rise in crude oil prices, for whatever reason, can further pull down growth prospects. In addition, apprehensions that the US will begin to slow down in the second half of this year are emerging. On the other hand, the world knows how reluctant Russia is in implementing production cuts. The output data coming out of Russia are taken with a pinch of salt.

So, the crude market is quite precariously poised. There may be occasional price spurts testing $70 a barrel; but that level is not likely to last given demand-supply fundamentals.

The outlook is good for oil importing countries such as ours; but we cannot take this outlook on current reckoning for granted. This is a market that changes with kaleidoscopic rapidity; and risk management is imperative.

The writeris a policy commentator and commodities market specialist. Views are personal

Published on February 07, 2019
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