By NS Ramaswamy
The geopolitics of oil and gas (resulting from the balance between supply and demand) is heating up. Crude oil prices are predominantly influenced be geopolitical tensions or war in an energy-producing country. It’s impacting the power dynamics between energy exporters and importers, energy security, and the military strength of major powers.
Let’s unwind – When Russia attacked Ukraine, the price of crude oil in the global market skyrocketed from around $76 per barrel at the start of January 2022 to over $110 per barrel on 4 March 2022. Oil prices were rising globally even prior to the full escalation of the war.
Across the globe the costs of production and manufacturing is greatly influenced by the oil price. Increases in oil prices can depress the supply of other goods because they increase the costs of producing them. In economics terminology, high oil prices can shift up the supply curve for the goods and services for which oil is an input. Significant component of the inflation is the rise in crude oil price which is more to do with the supply constraints and logistic bottlenecks and not any indicator of strong economies or greater demand.
Demand-Supply factors include the levels of oil consumption, oil reserves, global exchange rates, environmental issues, politics, and oil speculation on the financial markets.
Every product emanating from oil, everything from personal protective equipment, plastics, chemicals and fertilisers through to aspirin, clothing, fuel for transportation and even solar panels has an impact.
Oil prices are expected to hold steady as of now and the potential impact of an economic recession is not yet priced in. The global economy decelerations are in the forefront to watch for. In the past five US recession’s oil prices slumped on an average of 30% to 40%.
In the recent trading sessions, oil prices had choppy movements. There are fears that U.S and EU will continue facing headwinds in taming inflation which is dominating in all public forums. The bearishness of the US/EU was somewhat offset by Chinese promises of stimulating the economy and reorienting their oil industry to a more export-oriented focus.
Eyes are on china-reopening driven commodity boost, but we are still not there yet. Everyone is pining on that. There are rumours on China cutting the quarantine period for visitors to 7 days from 10 days. China being the world’s largest crude importer it’s weighing heavily on business and economic activity and lowering demand for fuel. Will their zero tolerance policy be maintained till next year? China’s GDP data continues to remain a mystery and is not priced in Crude Oil.
U.S Shale producers have kept a lid on supply amid pressure from shareholders to maintain capital discipline and use profits for dividend payments and buybacks rather than for pumping up production. Shale oil producers are hesitant about new investment because oilfield services inflation is the highest in a decade or longer.
Short Term (3 months) – Possibility of $100 but could range $75 – $95 (MCX Rs 6100 to Rs 7800);
Long Term (6–12 months) – Broader range $67-$110 “Based on fundamental triggers” (MCX Rs 5500 to Rs 9000)
Triggers and key headwinds for Crude Oil price direction
-One could expect fresh trouble with the supplies during winter as global tension still lingers.
-EU ban on Russian crude and oil products have been very supportive for oil prices.
-Risk of Russian supply disruptions due to the price cap (Deadline by G7 is 5th Dec) could tighten the market further.
-Slowing global economy and soft demand from China.
-Traders feared a slowdown in US economy while combating inflation with rising interest rates which is likely to see recession and could dent the crude demand.
-U.S plans to release 15 million barrels of oil from Strategic Petroleum Reserve (SPR) is disregarded by the market participants as the rise in supply will be offset by the OPEC+ production cut. In an apparent move to boost oil prices OPEC+ announced a 2 million barrel per day cut in the group’s production quotas from November 2022 which is a turning point for the oil market.
Oil prices are likely to remain about an average $60 per barrel through 2024. Concerns on transition away from fossil fuels, finding alternatives to petroleum is crucial to global energy use and is the focus of many industries. Market believes that the peak oil would occur within two decades from now. Historically, Crude oil reached an all-time high of $147.27 in July 2008.
(NS Ramaswamy is Head of Commodities, Ventura Securities. The views expressed are the author’s own. Please consult your financial advisor before investing)