Oil prices are heading for a spike of significant proportions. While most economies backed by the energy markets are minting money, other economies on the import front are reeling under the effect. Oil prices had commenced at $60.10 per barrel at the onset of the year. Prices slowly ascended at $75.25 per barrel on 3 July with an increase of 25%. A further hike is looking increasingly possible creating a déjà vu situation of 2008 in the not too distant horizon.
Problems emanating from the volatility in Iran are worse than most analysts expected. Likewise, bottlenecks in the US Shale could avert non-OPEC supply from filling the gaps. Additionally, new regulatory parameters from the International Maritime Organisation set to take adverse effect from next year could also significantly tighten supplies. Bank of America Merrill Lynch (BofAML) has fixed a target for $95 per barrel by June 2019. In hindsight, oil spiked to $147.90 in July 2008.
On the supply front, the picture is looking increasingly worrisome. Major reasons from Iran and Venezuela are driving up oil values in the fourth quarter. Estimates from BofAML have increased its forecast of supply losses from Iran to one million barrels per day (mbd), an increase from 500,000 bpd. US Shale can partially bridge the gap but the explosive growth from Shale drillers is starting to slow down in part because of pipeline bottlenecks. BofAML predicts US supply growth of 1.4 mbd in 2018 but only 1 mbd of growth in 2019.
On demand side, the equation looks unclear. However, market pundits have put their bet on strengthening demand in the forthcoming days. International Energy Agency (IEA) has predicted demand growth at 1.4 mbd and surprisingly the BofAML has concurred on the matter. However, the bank has put forward three factors to watch which could undermine the scenario of high prices. First, the greenback could strengthen, preventing a run-up in the prices in the same way as in 2008. Secondly, the higher debt levels in the emerging markets indicate that many countries are at a weaker spot than they were in recession years of the last decade. Third, capital could be drained out of the emerging markets because of rising interest rates from the Federal Reserve, tax cuts and tariffs.
The focus on the emerging markets cannot be understated. Although there are high chances of contagion, emerging markets represent the bulk of the growth in the demand for oil. Any hitches in emerging markets will upset the global demand picture. The appreciating US Dollar, higher debt and enhanced capital flight are all pointing towards the opposite.
There are other ingredients which could drive dramatic price spikes even if corresponding demand destruction makes the spike only temporary. BofAML estimates the total global supply outages at around 3 mbd-numbers a tad lower than the recent peak of about 3.75 mbd in 2014. Likewise, the figures do not account for the unfolding losses from Iran. In mere words, if Iran loses around 1 mbd of supply due to US sanctions, the total global supply outages could swell to their highest in more than two decades - not witnessed since the rough 5 mbd of outages during the 1990-91 Persian Gulf War. Saudi Arabia has officially claimed that it could cover the losses from Iran even if their producers completely halt their operations. Unauthentic sources have suggested that they could produce up to 12-12.5 mbd if the market requires it. But sources in a Wall Street Journal write-up state that “producing 11 million is already a stretch even for just a few months.” With the production already at 10.4 mbd, it leaves a significantly smaller pile of spare capacity than is commonly thought of.
As we approach the conclusion of the year, technical and fundamental analysis of oil are signaling bullish and quite a potent recipe for a delicate cocktail. The mantra seems to be consistent as a growing number of market practitioners are raising the bar for oil.
Vivek Risal is associated with Mercantile Exchange Nepal Limited in the capacity of Manager in Research and Development Department. He can be contacted at r&[email protected]
