No shortage of suspects when looking for cause of oil price plunge
What sell-off comes down to, Joe Chidley writes, is interplay of supply and demand.
What the hell happened to oil? Wasn’t it only a few weeks ago that energy analysts were talking up the return of US$100-a-barrel crude? Didn’t benchmark West Texas intermediate soar through September, cresting above US$75 in early October? Wasn’t the return to U.S. sanctions on Iran going to put a supply shock in play? Wasn’t Venezuela’s struggling oil industry rapidly slipping from crisis to full-blown debacle? How can all that change basically overnight? What the hell happened?
So many questions. And too many answers — there’s a coalition of bearish factors to choose from when trying to explain the 25-per-cent decline over the past five weeks. But what the sell-off really comes down to is the interplay of supply and demand, and the changing dynamics of both.
That’s not to minimize the impact of market sentiment, which abruptly switched negative. One of the key watersheds was the surprising American moderation in re-imposing those sanctions on Iran. The sanctions, which went into effect on Nov. 5, would functionally have cut off or penalized importers of Iranian oil, and judging from the run-up in prices before this month, it was almost as if investors thought Iran’s exports would drop to zero — which they never would have. But then the U.S. issued waivers to eight countries to keep on buying at least some oil for another six months. Together, those waiver recipients comprise the lion’s share of Iranian oil exports; for a market stoked on the prospect of a sanction-inspired shock, that was a huge disappointment.
However much the U.S. waivers impacted market sentiment, Iran sanctions are still not nothing in real terms. By some estimates, Iranian exports will decline during the waiver period to as little as 1.4 million barrels per day, from their peak of nearly three million bpd in the middle of the year. And remember, those waivers last only six months; after that, Iranian exports are very likely to drop even further.
It’s also worth pointing out that the price decline really began in early October, a month before the U.S. announced the waivers. On Oct. 3, when global benchmark Brent crude was sitting around its own fouryear high of around US$85 a barrel, Saudi Arabia and Russia announced that they were increasing production in October and November; it was also reported that the Saudi and the Russians had agreed privately to raise production throughout the remainder of the year, in part in response to U.S. pressure to put a cap on prices. That was on top of already ramped-up production from the two oil giants: in September, Russia pumped more oil than it had at any time since the demise of the Soviet Union, and Saudi Arabia produced 100,000 more bpd than it did in August. October production, meanwhile, maintained those elevated levels.
By then, the answer to one of the major uncertainty points on the supply front — how much OPEC and other producers could step up to meet any Iran-related shortfall — had already become clear, and the answer was “completely, and then some.” In fact, the International Energy Agency noted in its November report that oil supply had been rising since the middle of the year, with production gains “in the Middle East, Russia and the United States more than compensating for falls in production in Iran, Venezuela and elsewhere.”
This week, financial markets caught a bit of a break, when speculation mounted that Saudi Arabia would lead OPEC+ (the Organization of Petroleum Exporting Countries plus Russia and other allies) to lead a millionbarrel production cut in coming months. But the lift to prices on Wednesday — less than one per cent for WTI — suggests that even such assurances might fall short of restoring bullish sentiment.
You have to look at the context. Oil’s slide has coincided with a sharp sell-off in equity markets, which in turn has coincided with mounting fears over the U.S.China trade war, rising interest rates, the soaring greenback and corresponding impact on emerging markets, and a dimmer outlook for global growth. There is not much OPEC+ can do about those things, and all of them add up to slowing demand for oil.
Another thing OPEC+ can’t control is the American industry. As prices recovered through the summer, U.S. oil output topped 11 million bpd — contributing one million bpd to a 1.8-million-bpd increase in global output since May, according to the IEA. In short, those who expect a supply crunch might be underestimating the elasticity of the North American shale industry, whose technology allows far more flexibility over supply — effectively turning the taps on and off as price dictates — than conventional producers can manage.
So if you’re looking to understand why oil prices have fallen, it’s a pretty simple arithmetic: supply goes up, demand goes down, prices go down.
Saudi energy minister Khalid al-Falih put it nicely back in October, when he said the run-up in crude “was not based on fiscal flows of supply and demand. This is created in financial markets.”
In other words, the biggest wonder about oil prices isn’t why they’re so low now, but rather why they were so high before.