Commodity Analysis

Will oil go up to $100 a barrel?

Anand Kalyanaraman | Updated on October 07, 2018 Published on October 07, 2018

Oil has staged a strong comeback, but the rally may have run its course

For India, which imports more than 80 per cent of its crude-oil requirement, the past year-and-a-half has not been a good one on energy pricing. Global oil price (Brent) and, along with it, the price of the Indian crude-oil basket has nearly doubled since mid-June last year — from about $45 a barrel to $85 now. This is a sharp reversal from the rout that saw oil prices crash from about $115 a barrel in mid-2014 to less than $30 in early 2016, before recovering to $45-55 levels.

The rally in oil has adverse implications on several macro-indicators such as the country’s import bill, its current account deficit and the currency value, with these parameters feeding into each other. The recent rout of the rupee to around 74 a dollar is, in large parts, due to the relentless rally in oil prices.

Until last year, the popular wisdom was that crude oil was unlikely to go beyond the $65-70 a barrel mark. This was based on the assumption that US shale oil would make a strong comeback, and higher output would keep a cap on prices. But yet again, oil has proved that trying to forecast its movement is a mug’s game, with multiple global factors and uncertainties at play.

The sharp rally over the past year-and-a-half has been aided by a few factors. One, the output-cut deal between OPEC (Organization of the Petroleum Exporting Countries) and some major non-OPEC players, including Russia, finally showed results and squeezed out much of the excess oil inventory in the market. Two, the economic meltdown in Venezuela, a key oil exporter, has resulted in a sharp cut in the country’s oil production.

Third, and most importantly, the US, under Donald Trump, pulled out of the Obama-led nuclear deal with Iran earlier this year and re-imposed economic sanctions on Iran. The latter’s oil exports, which had picked up in 2016 and 2017 after the nuclear deal, has again fallen in the past few months. Many companies and countries, including India, seem unwilling to risk economic penalties (from the US) that could ensue if they continue importing from Iran.

With the full impact of the sanctions to kick in from November 4 — from when the US wants countries to halt all oil imports from Iran — there are apprehensions of a sharp supply squeeze in the global oil market. Estimates suggest that 1 million barrels per day or more could be lost from supplies once the Iran sanctions take full effect. That’s about 1 per cent of the global consumption of about 100 million barrels a day.

Responding to higher oil prices, the US shale oil industry has sharply stepped up its output But infrastructure and transport bottlenecks in the country have so far crimped exports and not put a cap on the global oil-price rally.

The upshot? Aided by multiple factors, oil has staged a strong comeback.

How far up can oil go? Can it again reach $100 a barrel mark as being suggested by some analysts? Nothing can be ruled out for a commodity that has swung from $115 to $26 to $85 a barrel in four years or so.

Burned out?

That said, the rally may have run its course and could take a breather sooner than later. A few factors support this view.

One, there is pressure from the US on OPEC (primarily on Saudi Arabia, the key oil producer and US’ geopolitical ally) and other major oil producers to moderate oil prices by stepping up output and make up for the shortfall that is expected to arise from Iran sanctions. This is essential for the success of the US actions on Iran. Saudi Arabia and Russia have reportedly agreed to ramp up oil output and fill the gap. While opinion is divided among oil analysts about whether this will be sufficient enough to make up for the shortfall, supplies are nevertheless expected to increase meaningfully and should cap a further sharp rally in oil prices.

Besides, the deal between OPEC and non-OPEC countries to cut oil output and support oil prices is on until December 2018. With the objectives of the deal having been met, the agreement will likely not be extended any more; this should mean additional supplies. Oil prices beyond a reasonable level invariably results in demand shrinkage, as seen in the past. This is something the oil producers will want to avoid. Also, with the Saudi Aramco initial public offering being put in cold storage for now, Saudi Arabia has fewer incentives to keep escalating oil prices.

Next, how successful will the US move on Iran be, needs to be seen. With the US and China engaged in an escalating trade war, the latter could choose to continue importing from Iran at discounted rates. Other countries such as Turkey that are also locked in economic disputes with the US could continue imports from Iran. This could mean lower-than-expected supply disruption in the market. Also, unlike the earlier sanctions, the US does not have the support of the EU this time. The EU nations are reportedly working on a ‘special purpose vehicle’ to workaround the US sanctions and continue trade with Iran.

If the escalating tariff war between the US and China crimps global economic growth, that could reduce oil demand and cap prices.

On the other hand, the risk of rise in oil prices to $100 a barrel cannot be completely ruled out. Increased risk of armed conflicts in West Asia, if Iran retaliates, could cause a supply shock. Also, the pain in Venezuela could deepen with economic conditions worsening and due to the impact of US sanctions; this could further squeeze output there.

India, its consumers and oil companies would rather that oil takes a break now; they are feeling the pinch badly.

Published on October 07, 2018
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