A stronger oil price has been blamed as one of the causes of recent inflationary pressures seen globally. So, does the improvement in the oil price indicate that global demand is improving? Or, is it speculators betting that OPEC cuts will constrain the market?
The answer is really a combination of the two.
Global demand has been growing steadily for a while now. According to Citi Research, an extra 1.69 million barrels were consumed each day in 2017 than the daily 2016 levels. This represented a 1.8% jump with demand in emerging markets growing stronger than in the OECD. Even China which has seen a big jump in electric vehicles (EV’s) consumed an extra 620,000 barrels per day.
Supply has been constrained by OPEC and Russia agreeing to restrain output. The deal was mostly orchestrated between Russia and Saudi Arabia and seems part of a bigger political power play in the Middle East.
A few years ago, we saw supply race ahead of demand leading to an oversupply. Oil markets place a lot of emphasis on reported inventory levels. These got to be quite high in 2016 but have fallen quite a bit last year as shown in the chart below.
Weekly Crude Stockpiles (Billions of Barrels)
We are now much closer to a balanced market; so, where to next?
The big threat to OPEC maintaining global supply discipline remains US shale. The entrepreneurial spirit of the US drillers got hit in 2014 and 2015 after the oil price collapsed from over US$100 a barrel but they adapted. Technological advancements have seen them cope with lower oil prices and they should be able to maintain production over the rest of 2018. It may even grow from here despite the pullback a few weeks ago as many took the opportunity to hedge beforehand. The US now exports significant barrels of oil. Hence, OPEC’s cuts may end up being in vain.
Whilst the market is currently in balance, it should tighten over the rest of the year. As we move into 2019, will OPEC maintain discipline and will the US shale boom continue? The growth of EVs are likely to accelerate and will be at a tipping point in a few years when they become cheaper than the equivalent car.
However, the impact of EV’s is more for next decade. In the meantime, the oil price should continue to improve as global growth continues and supply discipline largely holds.
Disclaimer: This article is intended to provide general information only. It does not take into account your investment needs or personal circumstances. It is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to an Authorised Financial Adviser.