Commodity Analysis

Will volatility in crude oil continue?

Anand Kalyanaraman | Updated on November 02, 2019 Published on November 02, 2019

Without supply shocks, it could stay between $60 and $70 a barrel in the coming year

Living up to its reputation for fickleness, crude oil has been on a roller-coaster ride. About a year back, in early October 2018, global crude oil prices (Brent) had shot up to $85 a barrel — nearly doubling from $45 a barrel in June 2017.

But within a quarter — 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, there was a sudden spike to over $70. But this was short-lived and Brent has since then fallen back to about $60 a barrel.

 

Key drivers

Driving this sharp volatility is the interplay between 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 should continue to have a bearing on the fuel’s direction ahead.

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 major non-OPEC players including Russia, and b) the US government under Donald Trump deciding to re-impose 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 from 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 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 the 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. 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 has been hovering at around $60 a barrel.

Outlook

Where is oil headed? Trying to forecast the fuel’s movement has always been a mug’s game, with multiple global factors, uncertainties and speculative forces at play. That said, it seems that oil could stay range-bound between $60 and $70 a barrel over the coming year.

Global economic growth and consequently, oil demand growth is expected to remain weak.

The continuing US-China trade war adds to the depressed demand scenario. Also, oil output from the non-OPEC+ countries, including the US, are on the rise, leading to increase in inventory levels.

The International Energy Agency has recently said that the oil market might see an oversupply situation in 2020. This suggests that there could be a cap on oil prices at around $70 a barrel levels.

On the other hand, the output cut agreement by the OPEC+ group that is on until March 2020 may put a floor on oil price around $60 levels.

The OPEC+ group will assess its options in its meeting in early December, and a deeper output cut decision to support oil prices cannot be ruled out in the context of expected weak demand growth.

The joker in the pack is the geo-political situation in West Asia that remains a tinderbox. There is a risk of escalation in military tensions between arch-rivals Iran and Saudi Arabia – this could translate into oil supply shocks and soaring prices.

This scenario would clearly be undesirable for India, which imports more than 80 per cent of its oil requirement and is currently facing economic growth challenges.

Published on November 02, 2019
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