Why oil prices fell back last week
After the killing of Iranian Gen. Qassem Soleimani by a US drone on Jan. 3, oil prices spiked, temporarily hitting a high for Brent of $70.9 per barrel. Analysts were caught in two camps — those who felt geopolitical tensions would send prices sky high and those who felt that the underlying supply-demand picture did not warrant higher prices for a sustained period of time. The assessment of the second group won out. Oil has lost more than 8 percent from its high, with Brent reaching just over $65.03 in Monday’s early European trading.
The price of oil has, for some time, lost its benchmark role for geopolitical tensions in the Middle East. This is due to several reasons. First, in December 2018, the US became the world’s largest producer of oil, relegating Saudi Arabia and Russia to ranks two and three, respectively, thanks to the Permian Basin and its seemingly endless gift of shale oil. Crude flows from the Middle East have become less important to the US. However, it looks different for the big economies in Asia. In 2018, Japan imported more than 80 percent of its oil from the Middle East, while the world’s largest importer of crude oil, China, imported just shy of 44 percent from the region. This means that these Asian nations are disproportionately exposed to geopolitical tensions.
Secondly, traders tend to look at the commodity from a global supply and demand perspective. The International Energy Agency (IEA) forecasted last December that it expected demand to grow by 1.2 million barrels per day (bpd) in 2020. It sees an increase in oil supply from non-OPEC countries of 2.1 million bpd for the same year. Its executive director, Fatih Birol, told Bloomberg during the Atlantic Council Global Energy Forum in Abu Dhabi that he predicted excess oil production of 1 million bpd to last through 2020. We will know more when the IEA releases its monthly oil market report this week.
It is safe to say that geopolitics will matter less to markets as long as supply significantly outstrips demand — unless of course an event has a sustained impact.
The long and short of last week’s market tribulations can be summed up as follows: Markets are looking at geopolitical tensions in the Middle East as event risk as long as markets are rather relaxed. They will spike when an event occurs and then lose their gains rather quickly. We saw that last May, when ships in the Strait of Hormuz were attacked; in September, when missiles and drones attacked the Saudi Aramco facilities in Abqaiq and Khurais; and after the killing of Soleimani.
Things would look different if there were events that had a sustained impact on oil trade or markets, such as a sustained blockade of the Strait of Hormuz. Given that China and Japan both depend on the strait for their oil supply and that both countries are on friendly terms with Tehran, Iran is unlikely to undertake any actions that would affect the strait for a sustained period of time.
Last year saw little volatility in oil markets except for the aforementioned spikes in the wake of geopolitical events. This can, by and large, be attributed to the efforts of OPEC+ (the alliance of OPEC and 10 allies, led by Russia), which managed to balance markets by adding oil or withdrawing it as required.
It is safe to say that geopolitics will matter less to markets as long as supply significantly outstrips demand — unless of course an event has a sustained impact. Traders tend to price in quantifiable trends. As long as geopolitical tensions are not quantifiable and occur on an ad hoc basis, they will be treated as an event risk.
• Cornelia Meyer is a business consultant, macroeconomist and energy expert. Twitter: @MeyerResources