The oil market is currently seeing a major disparity between the fundamentals and the positions of oil traders. While the fundamentals and several geopolitical factors would indicate that the prices should have risen or at least remained stable over the last few weeks, the prices have instead dropped precipitously.
Trading over the last two and a half weeks has sent down based on global economic fears, but the fundamentals and geopolitics did not call for that behavior.
Sentiment Vs Forecasts
The disparity between fundamentals and trader perception can be seen clearly in a recent Wall Street Journal survey of bank forecasts for prices. The survey found that the banks believe that the average price of Brent oil for 2019 will end up at $69.73.
For comparison, that is almost $10 higher than the price was at the middle of the day on Wednesday. These forecasts are based on supply fundamentals. According to these numbers, oil prices should go significantly higher. Brent would need to average more than $70 per barrel for the remainder of the year to meet these forecasts.
Right now, production is down from key oil producers, but market sentiment isn’t behaving like the fundamentals indicate it should. Instead, traders are focused on macroeconomic concerns like the slowdown in global economic growth and trade wars. According to the Wall Street Journal article, bank analysts have apparently decided that traders will ignore these macroeconomic concerns for the rest of 2019, even though these issues have been the driving force over the last several weeks.
Why Aren’t Oil Prices Higher?
According to the numbers, oil prices should be higher. U.S. sanctions on Iran and problems in Venezuela have caused production and exports from these key oil producing countries to plummet. Meanwhile, war in Libya has hobbled production there and could, officials have warned, cause production to “collapse at any moment.”
Production in Kazakhstan has been down due to maintenance on its largest oil field and is only now coming back up. Russia has suffered a huge blow with contamination on its 1 million bpd Druzhba pipeline, and its oil production is now down to 10.87 million bpd. This is the lowest production reported from Russia since mid-2016.
By all accounts, these supply issues should have pushed prices higher these past few weeks, but they haven’t. The question then is whether these issues will drive prices higher in the second half of 2019, or whether the same sentiment will continue in the market. It seems that some of the forces that should be pushing prices up will soon be resolved, including the outages from Kazakhstan and Russia. That would indicate less of an upward pressure.
Macroeconomic Shocks Could Drive Prices
Absent a major change, there just don’t appear to be any new forces pushing prices higher other than those that are already in place. Such a major change would be unpredictable, like an all-out war in the Persian Gulf, a severe natural disaster in an oil producing region, or some truly shocking supply or demand numbers.
But the same issues of sanctions, failures in Venezuela, and tight supply are already in place. If they aren’t making prices rise or prevent a fall right now, will they make prices much higher in the second half of the year?
On the other hand, the issues that are pushing oil prices down, or could push prices down in the future, don’t seem easily resolvable and could definitely worsen. The trade war between the United States and China is a major factor. When new tariffs are announced, oil prices drop. Negotiations don’t appear to be heading towards a resolution anytime soon, although that could change at any time.
We just don’t know if or when it will be resolved. It is certainly possible that Presidents Trump and Xi could reach a settlement before 2020 with enough time for higher oil prices to average out to near $70, but it is just as possible that the situation could get worse and prices could continue to drop.
Fundamentals Hard To Predict
Right now, markets are obsessed with economic indicators that might mean an impending recession. Oil traders have latched onto numbers that show slowing growth. Last week, the focus was on falling bond yields. Before that, markets focused on J.P. Morgan’s second quarter growth estimate for the U.S. economy, which cut its prediction of growth from 2.25% to just 1% . Before that, the market focused on Chinese data showing slowing economic growth.
This month’s OPEC meeting could push prices down further. There are three possible outcomes right now: a rollover of current production quotas, further production cuts or a complete implosion of the OPEC and OPEC+ agreement that results in the end of the production restraint deal. Russia seems unlikely to support further cuts, so the best OPEC can hope for is for a continuation of the current production quotas. Any kind of disagreement or deviation from this would send prices down.
This situation reveals the difficultly of trying to predict oil prices. As Saudi oil minister Khalid al-Falih said earlier this week, the price volatility seen in oil recently is “unwarranted.” Of course, as the Wall Street Journal article stated, this hasn’t stopped institutions from making predictions for the average price of oil… in 2020!