Commodity Analysis

Where is crude oil headed in 2020?

Anand Kalyanaraman | Updated on January 19, 2020 Published on January 19, 2020

Just how volatile and fickle crude oil can be was on full display over the past fortnight. The assassination of top Iranian military general Qassem Soleimani by the US government on January 3 sent tensions between the two countries soaring and raised the spectre of an all-out war.

An oil supply shock could possibly have ensued — had Iranian counter-attacks killed US personnel, or if Iran had attacked key US allies such as Saudi Arabia, the United Arab Emirates or Israel, or if it had choked the Strait of Hormuz, a critical global oil trade route. Oil prices shot up on such worries, with benchmark Brent up $3 in a day to nearly $69 a barrel, and set to rally further.

Thankfully, despite the bellicose war rhetoric by both the sides, the Iranian retaliation that came within days was relatively muted. Iran stopped, at least for now, after missile attacks on a couple of US military bases in Iraq that reportedly did not result in loss of lives.

 

 

 

The US did not react and tensions eased somewhat, even if temporarily. Oil prices calmed down and Brent retreated to $64-65 a barrel, around which it currently hovers. There was significant ‘collateral damage’ though — the fog of war saw a Ukranian civilian aircraft being shot down by mistake by Iranian forces, resulting in the tragic death of 176 people on board.

It may have cooled off for now, but will oil stay that way in 2020?

It’s a mug’s game trying to predict the fickle fuel’s movement — with multiple global geopolitical factors, uncertainties about demand and supply, and speculative forces at play. That said, an idea of the factors that have moved the see-saw in the past could give some pointers .

Even before the recent spike in US-Iran tensions, oil prices had been yo-yoing over the past year and half. In early October 2018, Brent shot up to $85 a barrel — nearly doubling from $45 a barrel in June 2017. By end-December 2018, it had fallen all the way back to below $50 a barrel. Oil then shot up again, crossing the $70-mark by May 2019, only to dip below $60 by August. Then, in mid-September 2019, there was a spike to over $70. But this was short-lived and Brent soon fell back to below $60, only to rise again to $67 levels by end-December 2019. The New Year, heralded by escalation in tensions in West Asia, saw prices move up close to $70, and then let off some steam to settle around $65 a barrel now.

Key drivers

Driving this sharp volatility is the interplay among five main factors — oil output cuts by major producers to tackle oversupply and support prices; the US sanctions on Iran; weak global economic conditions that dented oil demand and prices; and geopolitical and trade tensions. These factors will continue to have a bearing on the fuel’s direction in 2020.

The sharp rally from June 2017 to October 2018 was primarily due to a) the output cut deal between the Saudi Arabia-led OPEC (Organization of the Petroleum Exporting Countries) and some non-OPEC players including Russia, and b) the US government under Donald Trump deciding to reimpose sanctions on Iran.

While the output cuts squeezed out most of the excess oil inventory in the market, the run-up to the sanctions on Iran saw the country’s formidable oil exports dip significantly.

But then, the last-minute decision by the Trump administration to grant a six-month waiver on Iran sanctions to eight major oil importing countries, including China and India, led to oil prices dipping sharply by end-December 2018. The price fall was exacerbated by worries about the impact of the US-China trade war on global oil demand.

The rapid price dip to under $50 a barrel saw the OPEC+ group decide to cut output by a steep 1.2 million barrels a day, from January 2019.

This, along with the impending end of Iran sanction waivers, saw oil recoup to above $70 by May 2019. But then, the ratcheting-up of the US-China trade war and the weakening global economic growth took a toll and dragged down oil to below $60 a barrel, by August.

But the pendulum swung soon again in mid-September 2019. Major drone attacks on Saudi Aramco’s key oil processing facilities at Abqaiq and Khurais knocked off about half of Saudi Arabia’s oil production, sending prices shooting to over $70 a barrel. The Saudis blamed Iran for this attack.

Saudi Arabia’s tapping into its oil reserves to maintain exports and restoring the damaged facilities within a couple of weeks saw oil prices cool off again to below $60 a barrel by end-September. Tension spiked again in mid-October when an Iranian-owned oil tanker was struck, probably by missiles, off the Saudi coast. Oil, though, did not react much to this incident, and stayed around $60 a barrel.

In early December 2019, oil prices started rising again; this was due to the OPEC+ group deepening output cuts from 1.2 million barrels a day to 1.7 million barrels a day, effective January 2020 until March 2020, in response to risks of weak demand growth and oversupply conditions. Add to this the US-Iran standoff in January, and oil was on boil again before cooling off somewhat.

Outlook

While it is difficult to predict oil’s trajectory, it appears that it could stay range-bound between $60 and $70 a barrel over the coming year. Oversupply conditions are likely to persist despite the OPEC+ output cuts. The International Energy Agency (IEA) had recently said surging oil production from non-OPEC countries led by the US, along with abundant global stocks, should help the market weather political shocks such as the US-Iran stand-off.

US shale oil output, the game-changer in the oil markets in the past few years, gets a boost when global crude oil prices rise. Additional supplies from this key non-OPEC source should put a cap on the oil price at around $70 a barrel. On the other hand, it seems unlikely that oil will fall below the floor of $60 a barrel. A fall below this level will possibly see the OPEC+ cut its output further to support prices.

Also, the outlook for global economic growth and hence oil demand seem to have improved somewhat in recent days, with the thaw in the US-China trade tensions. Given the on-off nature of this key equation in the past, how it eventually plays out needs to be seen. Also, the OPEC+ group’s decision on output cuts in its March 2020 meeting will be significant.

The joker in the pack is the geo-political situation in West Asia. Iran may have chosen to hold its fire for now, but it is unlikely to back off altogether, given that it is being increasingly boxed into a corner by tightening sanctions. Its recent full withdrawal from the 2015 nuclear deal and souring of relations with key European nations may be a sign of more aggression to come. Even so, going by how the recent stand-off played out, a full-scale war seems unlikely, with neither Iran nor the US having the appetite for it.

Iran could be overwhelmed by the US military machine in an all-out conflict; also, President Trump, who is seeking re-election, would not like to see fuel prices at the pump shoot up sharply due to oil supply shocks.

What could continue, though, are low-intensity attacks and counter-attacks, belligerent rhetoric and strategic withdrawals from the brink. This would be a more acceptable scenario to India, which imports more than 80 per cent of its oil requirement, and is currently facing its own economic growth challenges.

Published on January 19, 2020
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