Oil prices: How low is low?

Crude oil prices tested new lows last week and continued their downward slide on Monday, when Brent reached $61.06 per barrel in morning trading. Prices are 14.3 percent down month on month, and around 20 percent lower than their 2018 high.

As always, there are two forces influencing the oil price. On the one hand, there are geopolitical tensions in the Middle East, lower oil production in Iran and Venezuela, and uncertainty over Libyan and Nigerian production.

On the other hand, there are lowered growth forecasts for the global economy, which stand at 3.3 percent for 2018, according to the International Monetary Fund (IMF). The real threat to the oil price comes from trade tensions, because less trade and increasingly localized supply chains result in lower demand for crude.

At the start of the month, the bulls won. When four oil tankers were sabotaged off the coast of the UAE, and drones damaged two pumping stations of the important  East-West pipeline in Saudi Arabia, prices soared. The US sent a naval convoy to the Gulf in response, and as the rhetoric between Washington and Tehran ratcheted up, the oil price followed suit, reaching the mid-$70s per barrel by the midle of May.

Then the bears took over. As US President Donald Trump increased tensions in the trade war with China, global stock markets and the oil price fell with every instalment of new tariff threats and tweets, culminating in the US blacklisting telecoms company Huawei. This had a big impact not just on China’s economy, but also on the US tech sector. Huawei and other Chinese companies are major clients of Intel, Qualcomm and Broadcom.

Volatility would have been far higher if not for the production cuts of OPEC+, an alliance of the 15 members of the Organization of the Petroleum Exporting Countries and 10 allies led by Russia

Cornelia Meyer ​

Trump announced last Friday that he would impose a 5 percent tariff on Mexican imports by June 10 if the country did not do more to curb illegal immigrants entering the US. By October, the tariffs are set to rise to 25 percent if the Mexicans are unable to stem the flow from Latin America. Mexico is a vital trading partner for the US, and the supply chains of the two economies in the  automotive sector are highly integrated. Trump’s move raises questions over the US-Mexico-Canada Agreement (USMCA), which replaces the North American Free Trade Agreement (NAFTA). The USMCA was signed by the three countries last November, and is awaiting ratification. Trump’s latest move apparently decouples trade from economic drivers and therefore spooked equity markets, which lost across the board. It had a devastating effect on the oil price, which fell 3 percent on Friday.

Volatility would have been far higher if not for the production cuts of OPEC+, an alliance of the 15 members of the Organization of the Petroleum Exporting Countries and 10 allies led by Russia. The 25 states had decided to curb production by 1.2 million barrels per day (bpd) until June.

OPEC compliance stood at an astonishing 168 percent in April, admittedly also due to Venezuelan production having fallen off a cliff and lower Iranian production due to US sanctions. Russia had been pumping too much, but quality issues in its Druzhba pipeline, which transports Russian crude to Europe, resulted in Moscow complying with its share of the cut for the first time in May. OPEC+ ministers are slated to meet at the end of June in Vienna to discuss where to go next. A lot will depend on whether geopo- litical tensions or fears over trade wars have dissipated. US production has reached an all-time high of 12.3 million bpd, and exports are on the rise. This is more than compensated by lower Venezuelan and Iranian production.

Russian Energy Minister Alexander Novak is feeling pressure from several Russian producers that want to bring new capacity on stream and are not wild about production cuts. We will have to see in June and July how the Russia-OPEC friendship develops going forward.

What we can say is that volatility in the oil price would have been far higher if the safety valve of OPEC+ had not existed. The alliance allows for a quick response mechanism, putting more crude on the market when things are tight, and removing excess oil when fears over trade wars and the global economy prevail.

 

• Cornelia Meyer is a business consultant, macro-economist and energy expert. Twitter: @MeyerResources