The only way is up as oil prices start to stir
Oil prices are stirring again. Brent crude last week topped $68 a barrel for the first time since 2015 – and shows few signs of abating. Oil has now risen no less than 140pc since bottoming out in January 2016 and is up 35pc over the last six months.
During 2018, the path of crude will continue to reflect the ongoing “Opec versus shale” battle. As such, the mighty exporters’ cartel will try to keep prices high by limiting production. The gung-ho US shale industry, meanwhile, comprising independent and often heavilyindebted producers, will do all it can to pump as much as possible – which pushes prices down.
At the same time, numerous other geo-political tensions will swirl. Will Russia keep helping Opec by limiting production? Will tensions across the Middle East spiral out of control? Economic textbooks tell us prices are determined by supply and demand, based on commercial decisions by “rational agents”. The price of oil, perhaps the world’s most crucial single economic variable, isn’t like that. Crude is driven largely by politics – and 2018 will be no different.
Last week’s three-year oil price high is a case in point. Crude surged after demonstrations began in Mashhad, Iran’s second largest city, before spreading to other parts of the country, including the capital Tehran. Since securing a historic sanctions-lifting deal with six world powers in 2015, Iran has restored oil production to 4 million barrels a day (a hefty 4.2pc of global production).
Markets are spooked less by concerns that Iranian demonstrators will threaten the country’s oil industry directly. The fear is that a heavyhanded crackdown on protesters by the Iranian authorities will give President Trump the excuse he craves to re-impose sanctions, removing Iranian crude from global markets once more. Trump has never liked Obama’s Iran rapprochement and is itching to reverse it – a move that could send oil prices soaring.
At least part of the recent price rise does reflect economics. As the global recovery takes hold, oil demand has been rising. Since 2012, crude consumption has expanded sharply, from 90.6 million barrels daily to almost 97 million – a 7pc rise – and we’re now in the midst of the strongest period of oil demand growth since the 2008 global financial crisis. With the IMF forecasting 2018 global GDP growth at a chunky 3.6pc, and the Chinese government stockpiling oil with gusto, that bullish case for crude is taking hold.
Opec, which still controls around 40pc of global production, has every incentive to maintain current supply limits. The alliance the cartel struck last January with non-member Russia, has removed almost 2 million barrels from global markets daily, soaking up previously bloated inventories. In late November, that deal was extended through 2018, though it will be reviewed at the Opec summit in June.
The cartel’s kingpin, Saudi Arabia, clearly wants a continuation. The Desert Kingdom is now so cashstrapped that it is selling part of oil giant Saudi Aramco – the flotation price of which will be driven by prevailing crude prices. It’s not
entirely clear, though, that Russia wants to extend the deal. Once crude goes above $60, that encourages US shale producers to an extent that goes beyond Russia’s long-term interests.
The Saudis, facing political dissent at home and with a budget deficit that’s still around 10pc of GDP, need cash now – which is why Riyadh wants higher prices. The Russian government, in contrast, despite much of what you read, has an extremely strong balance sheet. Moscow’s reserves now exceed $500bn, up some 20pc over the last two years. The Russian budget, meanwhile, assumes $40 oil – so there is plenty of fiscal headroom.
What really motivates Moscow, rather than short-term cash, is long-term market share – as shown by growing exports to China. Russia last week opened an extension to the East Siberia-pacific Ocean, or ESPO, oil pipeline to China. This cements Moscow’s status as the leading crude supplier to its massive Asian neighbour, doubling export capacity to 220 million barrels a year. Saudi wants to maintain production constraints, but Russia may not agree.
As for the US shale producers, higher prices will of course give them access to more venture capital, encouraging them to pump like billy-o. The exploitation of “tight oil” fields in Texas, North Dakota and the Appalachians has pushed US oil output from 6.8 million barrels daily in 2006 to 12.4 million last year. The growth of America’s “non-conventional” oil production, which I initially underestimated, has been truly spectacular.
The US, which consumes 20m barrels daily, remains massively dependent on oil imports, of course. Shale hasn’t solved Washington’s geo-political headaches. But the expansion of American oil production over the last decade is a heady story of ingenuity and commercial grit. The US Energy Information Administration is already forecasting domestic shale output will rise by 780,000 barrels a day this year, more than double the 2017 increase.
Much has been written about electric cars and “the end of the oil era”. That won’t happen anytime soon. The global oil complex and the manufacturers of internal combustion engines, are two of the most powerful lobbies on earth. Oil demand will keep rising for years and probably decades hence. Those betting against this oil rally, though, hope that as the US shale producers up the ante, the recent Russia-opec love-in will cease. But that scenario would be instantly demolished if Trump wakes up tomorrow and launches a nasty tweet against Iran. Economics is rarely boring. Not least when politics prevails.
‘Crude is driven largely by politics – and 2018 will be no different’