Are markets turning positive on crude?
The stronger the message of unity between Opec and Russia, the better the outlook for the oil price
Recent surges in the price of crude oil saw the commodity hit twoyear highs in the first week of November.
Tensions in the Middle East appear to be pushing valuations into an upward trend. Geopolitical risk premium has been added into the Oil market, following developments across Saudi Arabia and the Middle East region over the past week. The potential for further political risk seems to have encouraged investors to purchase Oil, providing momentum for the commodity to reach its highest level in over 2 years.
In an interesting twist, the oil price is behaving as it does when the markets fear a supply shortage, as it did for many years before the 2014 decline.
Until recently, tensions in the Middle East have been largely been shrugged off by anxious investors, who have traditionally focused their attention on the persistent oversupply in the market. The latest reaction from investors towards buying Oil, following an emergence of what appears to be political risk in Saudi Arabia, might actually have been encouraged by improved fundamentals for the Oil markets.
Overall, investors seem to be more optimistic about oil markets and are pricing in an additional risk premium based on the political storms in the Middle East.
The hard numbers are mixed. Some of them appear, at least superficially, to support the case for the oil supply versus demand rebalancing act. For example, the number of US oil rigs fell in the first week of November, exciting the bulls who anticipated a cut in US oil supplies. The International Energy Agency (IEA) points to increasing demand for oil due to colder-thanexpected winters and the impact of lower prices on industrial consumers, who are gobbling up fuel at a higher rate.
The IEA expects global oil demand to increase by 1.2 million barrels per day until 2022. In a shower of cold water for the bulls, however, US stockpiles rose by 2.2 million barrels in the week ending 3 November.
The stakes are high for Opec, which meets at the end of November amid a plethora of political and economic sensitivities. Expectations for the outcomes of the meeting in Vienna are high - investors want to hear that the supply-cut deal will be extended, along with a strong commitment to continued rebalancing of the market. The messages so far have been consistent and this is one of the reasons why the markets have been supportive of Opec’s supplyside policies.
The stronger the message of unity between Opec and Russia, the better the outlook for the oil price. The recent historic state visit to Russia by Saudi Arabia’s King, has had another halo effect, offering signals that two of the major producers of oil are going to collaborate more closely in the future.
While it’s true that the market firmly expects Opec to again extend its current agreement to cut production, Opec’s chief Mohammed Barkindo has surprised markets by asking US Shale producers to discuss a potential collaboration. It is very unlikely to happen, due to Opec and Shale producers being direct competitors, but it’s clear that global producers would benefit from a stronger oil price. It’s apparent that other tactics to reduce US Shale output haven’t had a significant impact.
Opec’s latest outlook sees the US domestic oil markets expanding production to 7.5 mb/d by 2021. Ironically, Opecs cuts appear to have supported US Shale’s expanding production, making it more likely that the oil price will be cut back down to size after each rally.
Whether the markets stay positive towards oil, depends on what messages are sent during Opec’s Vienna meeting and to what extent the current geopolitical tensions will affect the cartel’s relationships and willingness to comply with supplycut agreements. The writer is global head of currency strategy and market research at FXTM. Views expressed are his own and do not reflect the newspaper’s policy.