In June 2008, three months before the collapse of Lehman Brothers and the onset of the Great Financial Crisis (GFC), the price of Brent crude oil briefly touched $145 per barrel, its highest level ever.
The Outlook for Oil
What’s beneath the surface
In June 2008, three months before the collapse of Lehman Brothers and the onset of the Great Financial Crisis (GFC), the price of Brent crude oil briefly touched $145 per barrel, its highest level ever. In the ensuing decade, it has not touched those heights again, despite a lengthy period (2011-14), when it reached nearly $130/bbl. Most recently, it has been trading at a little over $70.
Perhaps, the market’s doldrums reflect an increasingly disruptive combination of rising electric car sales and the growing use of renewable fuel sources – solar, wind, biomass – to generate electricity?
That’s not so. Electric cars currently represent less than 4% of worldwide car registrations and, while sales are growing apace, especially in China, they’re expected (by independent analysts; Elon Musk is probably more optimistic) to comprise no more than 11-12% of all those on the road by 2030.
Similarly, as far as electricity generation from oil is concerned, rising electric-car use is not a factor. Only 3.7% of the world’s electricity generation is now fuelled by oil.
A change is gonna come
Nonetheless, the International Energy Agency (IEA) observed in Oil 2019, its annual review, that “oil markets are going through a period of extraordinary change”. The principal reason is the strong uptrend in US production from shale deposits.
Although America’s extensive shale oil reserves had been known about since the mid-19th century, they were costly to develop and did not become profitable until the oil price rose above $50 in 2005. Thereafter, production has climbed steeply, especially since the GFC.
Consequently, the US, which became the world’s largest oil producer in 2018, is expected to become a net oil exporter in 2021 and, by 2025, to be the world’s second-largest exporter, after Saudi Arabia. That development, combined with growing output from Brazil, Canada, Norway, and Guyana, is forecast to keep a lid on prices for the next five years or so.
Note, however, that the outlook is merely for little change in prices; there is no expectation of a downturn. On the contrary, the oil price is well underpinned by trends on the demand side, where further growth is expected on the back of the continuing economic expansion of major new markets, notably, China and India.
However, the pace of that growth is likely to be slower. Primarily, this is due to the reduced economic tempo being experienced in the older economies. Those countries were, until very recently, expected to grow by around 3.5% in 2019.
During the final quarter of 2018, however, signs emerged that both consumer demand and business investment were tailing off. Accordingly, this year’s growth forecast for the leading developed economies has been pared to 3.3%, with only minor improvement expected in 2020.
The changes may seem minuscule, but they also undermine export prospects in developing economies and, thus, will have a significant effect on the projected worldwide demand for oil over the next five years.
Over the longer-term, however, demand will be underpinned by the continuing growth of China, India, and other developing nations in Asia, as well as in Africa. That demand is likely to focus on petrochemicals and, despite rising public opprobrium, on plastics, two of the main products derived from crude oil. Aviation fuel will be another important source of demand growth, according to the IEA.
What about the short-term? When Harold Macmillan, a former British prime minister (1957-63), was asked what he feared most as a politician, he’s said to have replied: “Events, dear boy – events”. Such ‘event risk’ is particularly evident in today’s world.
The American presidential election, this November, is a case in point. If Mr Trump is re-elected, his protectionist trade policies will likely be applied with renewed aggression. That would further restrain world trade and, therefore, the demand for oil.
The tortuous Brexit process – or lack of one – is another trade deterrent as, faced with an uncertain business outlook, companies across the EU will continue to hold back on already-delayed new investment.
On the upside, the parlous state of Venezuelan politics threatens to turn that major oil producer into an economic desert. Bereft of long-overdue investment in essential maintenance, its wells have become less-and-less productive, thereby tightening world oil supplies. The circumstances seem likely to deteriorate even further.
Venezuela isn’t the only producer suffering from a shortfall in output. Iran, subject to US economic sanctions, is another, while strife-crippled Libya is also struggling.
There is an underlying political and strategic tension to these opposing factors. Several members of the Organisation of the Petroleum Exporting Countries (OPEC) would like to support their own economic health by raising oil output. Russia is chief protagonist of that strategy. Other members, led by Saudi Arabia, want to maintain current production constraints in an attempt to stabilise the oil price at around the prevailing level of $70/ bbl.
Adding to this tension, President Trump has been waging a Twitter war, urging OPEC to increase output in order to reduce prices. He believes that will help to spur the US economy. Unsurprisingly, given its emerging dominance in the world market, the American oil industry begs to differ.
With so many unresolved geopolitical upsets, the possibility of a series of surprises is evident, whether it be the oil optimists or the pessimists that are wrong-footed when the mist clears. The same fog is also the perfect breeding-ground for rumour and speculation.
This background suggests oil prices will be unpredictable for the remainder of 2019, bumped up or down successively and, probably, often by breaking news. That should be a gift for nimble traders, while, for those who prefer long-term investing, it also provides opportunities to accumulate a relatively cheap position during price downturns.
But, whatever your approach, it’s best to consult a professional adviser before taking any action in such a specialised and opaque market as oil.