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Emotional Oil: Prices driven by sentiments and speculation

, December 26, 2017, 0 Comments

emotional-oil-india-marketexpress-inBrent crude oil prices have risen almost 20% starting September and there seems to be no fundamental reason for this rise. Much of the rise has been fueled by speculations over geo-political developments in the middle east.

Oil prices started rising at the end of 2016 after the OPEC and other nations decided on an output deal to balance the global markets. Oil ended 2016, almost 53% higher as compared to the start of the year. Oil prices started softening again in March 2017, as the deal was about the expire. However, further extension of the output deal lent support to oil prices again.

The sharp rise in oil prices in recent months can be traced back to a few events. In August and September 2017, Hurricane Harvey and Irma hit the US. This impacted the US oil infrastructure and disrupted physical supply of oil. US oil production declined by around 750,000 bpd in the week following the storm. This caused oil prices to move from early $50 levels to mid-$50 levels. But over the weeks the production recovered.

Turkish opposition to the Kurdish referendum in September was another factor that led to some geo-political tensions and lent support to oil prices. Turkey threatened to turn off an Iraqi oil pipeline after the country’s Kurds voted for independence in a referendum. This meant that Iraq would lose a chunk of its northern areas, which includes the crucial Kirkuk oil field and its surrounding reserves. Official figures say Kirkuk represents 10% of Iraq’s total production capacity.

Moving ahead in October, Kurdish oil workers abandoned Kirkuk oil fields ahead of the advance by the Iraqi government, which was backed by Iranian militias. News reports suggest this kept some 350,000 bpd of production offline. The military operation more than halved Kurdistan’s oil output and cuts its exports to global markets via Turkey by two thirds. Before the independence referendum for Iraqi Kurdistan, Kurdistan was exporting some 600,000 bpd. This again created disruption to oil supplies. Oil prices were flirting with the $60 mark towards the end of the month and crossed it in November.

Come November and Saudi Crown Prince Mohammed bin Salman’s anti-corruption campaign sends waves of political uncertainty. The anti-graft committee ordered the arrest of more than 200 suspects, including princes, prominent businessmen and former senior officials, on allegations related to corruption. At the same time, there were fears of escalation of war between Saudi Arabia and Yemen over a missile fired into Riyadh from Yemen. Though the tension between Saudi Arabia and Iran backed Yemen rebels is nothing new, but a direct attack on Riyadh took it to new levels. A full blown conflict could be very risky and damaging for both the countries. This can easily spook the oil markets (which it already has, to some extent). The conflict would expose oil fields in Saudi Arabia as well as Iran as potential targets. Additionally, this could jeopardize the oil flowing through the Strait of Hormuz – between the Persian Gulf and the Gulf of Oman. Around 25% of global oil trade flows through it.

The latest development being that of debt default in Venezuela. The country is a member of the OPEC and contributes to around 2% of global crude oil production and around 6% to OPEC’s output. There is sufficient spare capacity with other OPEC members to augment any supply shortfalls.

While all the above factors do impact oil prices, none of them as of now has altered the supply side dynamics on a sustained basis to justify such a sharp rise in prices. The global market is still oversupplied with oil. Fundamentally the situation remains unchanged over the last 10-12 months. OPEC is abiding by its output deal fairly well. There is a fair amount of market consensus that the OPEC output deal will be extended through 2018. There are potential fears of the OPEC agreement being breached by Iran – in the light of the decertification of the Iran nuclear deal. Libya and Nigeria have had fluctuating oil output. Global oil demand is rising. Crude oil in tankers has fallen by an estimated 40 million barrels this year. US crude inventories have also fallen. US shale’s growth has remained weak this year – given the cost side inflation. But sustained prices above $60 a barrel can stimulate a big supply side response from the US shale. US crude exports are making inroads into Asian markets. So it’s fairly safe to say that much of the oil price rise in recent months has more to do with sentiments and speculators than fundamentals. Prices are unlikely to sustain at these levels and moderate to 50s range.

Implications of high prices in India are fairly well known. Increased oil prices increase our import bill and put fiscal pressure on the government by way of increased subsidy – LPG and Kerosene. In its bid to contain the impact of rise in global prices on to the retail consumers, the government might undertake a reduction in duties and taxes on retail fuel – further fiscal pressure. Higher oil prices feeding into inflation are surely bound to irk the inflation focused Reserve Bank.

The author is a corporate economist. Views are personal.