Slowing demand, lull in global economy may exert pressure on crude prices

The crude oil market has been, of late, ruling firm, with Brent touching $68 a barrel and WTI $60. A combination of factors on the supply side has propped the market up. These include production cuts agreed to by OPEC+, involuntary outages from Venezuela and Iran and most recentlya sharp decline in the US oil stocks.

It appears that OPEC’s price objectives are met, at least for the time-being. Therefore, the oil cartel has now deferred its April meeting to June by which time the White House’s view on extending the exemption granted to Iranian oil exports will become clearer. The exemption expires in May.

The ongoing trade negotiations between the US and China are also being keenly watched. The outcome is sure to have a bearing on commodity prices.

The sharp fall in the US stocks is seen as an aberration in what otherwise is a steady expansion in production. There is a strong reason to believe that the US production will rise further. Current WTI prices provide producers with attractive margins given that the break-even cost is in the vicinity of $40 which should encourage production.

Additional boost to supplies will come from increased pipeline capacity in the shale region. If anything, OECD inventories have risen in the first quarter.

Global slowdown

But the directional change to the crude oil market is most likely to come, not from the supply side, but from the demand side. The market faces strong headwinds, not the least of which is apprehension of a slowing world economy.

Demand concerns are already beginning to take hold. The evidence of a global economic slowdown is mounting. Europe and Japan are already facing tepid growth prospects. China is decisively slowing and will continue to be so notwithstanding some recent attempts to stimulate the economy.

But a greater danger is the anticipated slowdown in the US, especially in the second half of 2019, as the positive effects of stimulus including tax cuts start to peter out and tighter credit conditions take hold. That’s a danger signal none can overlook.

Demand concerns

After all, the US and China together account for one-third of world oil demand. Slower economic activity will lead to demand compression. Recent data regarding automobile sales are far from flattering.

Demand concerns can exacerbate if the ongoing trade negotiation between the world’s top two economies collapses for some reason. In the event, crude bulls are sure to exit the market in a hurry, sending the market in a tailspin. Fundamentals will start to assert themselves again. On current reckoning, economic slowdown and demand compression appears to be a highly plausible scenario in the months ahead. The dovish stand of the US Federal Reserve in the recent FOMC meeting is widely seen to bear this out. In other words, current Brent price of $66-$68 a barrel is unsustainable in the face of mounting evidence of slowing growth.

Towards the second quarter of the year, Brent is likely to correct down towards $60 a barrel and in the second half, a further fall to $55is seen. This would, of course, be good news for import-dependent economies such as India.

Falling crude rates in the world market in combination with a rising rupee (expected to be in the 67-69 range to a dollar) is a fortuitous situation for the country. How well it is managed and how best benefits are drawn remains to be seen.

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

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