By Barry Newton, Managing Director, Geos Group
The only thing certain about future oil prices is the uncertainty of future oil prices. So ends the economics lesson for today! The following commentary is an attempt to look at all of the factors that affect the oil price and try to come to an educated guess on where we'll be this time next year.
Last year's OPEC intervention
A good place to start is with OPEC, the oil exporters club, who last year made a decision to reduce production and attempt to put a floor on prices. Bearing in mind that Brent crude oil was at $45.00bbl last July, having seen a drop to around $30.00bbl during 2016, it seems the OPEC decision was a good one with prices currently around $69.00bbl. The deal put in place by OPEC and some non-OPEC members sees a cap on production of 32 million barrels per day, and will be in place for some time yet (or at least until the OPEC meeting in June when it is due to be reviewed).
This is all good news for oil producers. But sustained higher prices, as we are seeing today, need to be maintained in order to drive further investment into the oil sector and ensure future resilience and economic stability. On the other hand, the bad news for consumers is higher prices on the forecourts and in our homes.
The great American story
There are many factors for oil producers to consider in their decision making, including production levels in the US on the back of shale oil production. The balance of power appears to be changing, with the US in a position of higher production, increased exports and greater self-reliance - all of which puts them in a powerful position. OPEC knows this and isn't keen on keeping it this way. The question is whether OPEC is even able to change the direction the market is going in.
Shale oil production is in full flow, prices are at a good level and production can be easily increased. On the back of this surge, US government energy analysts have increased their output forecast by four times in the past few months. If output goes over 11 million barrels per day as expected, then shale oil production will account for more than a ninth of global production. The production level is currently just below 10 million barrels per day.
Demand is increasing
Demand is another crucial factor in global oil prices. We saw demand picking up after Q1 in 2017, but prices didn't seem to be affected until the second half of the year. China and the US saw the largest increases in demand, with India struggling to recover after major economic heartaches (around tax and monetary changes) and reducing spending. Demand really increased during the last quarter of 2017 - when this happens at the same time as OPEC production cuts, the result is only ever going to be increased prices.
Geopolitical turbulence
Another factor that affects the oil prices is the geopolitical situation in countries around the world. Saudi Arabia saw a crackdown on corruption towards the end of 2017, and ministerial arrests seemed to be a catalyst for a rally in prices. There have also been issues between Yemen and Saudi Arabia, with missiles being fired and thankfully intercepted, with the added complication of the US accusing Iran of supplying Yemen rebels with the missiles.
These disputes continue today and all have an impact on the economic and political stability of the region. Iran also has internal issues, with many demonstrations about the economy and higher food prices, along with a 50% increase in petrol prices. This again leads to an uncertain period which the oil market doesn't like. The current geopolitical uncertainties are all bullish for oil prices going forward.
Global strength indicator
One final measure of where oil prices may go is the Global Oil Strength Index (GOSI), used to evaluate important issues and their effect on oil prices. It is designed to answer the question of whether oil prices will go up or down from where they are today. GOSI is reported as a number. If GOSI is less than 50 then the outlook is bearish; if it is at 50 then the outlook is neutral; if it is greater than 50, the outlook is bullish.
The latest GOSI was set at 55, which is slightly higher than the GOSI of 54 we saw in 2017. So a slightly bullish outlook, according to the GOSI index.
If you apply this rating to the other main protagonists of the oil market, being oil fundamentals of supply and demand, the geopolitical situation globally and global economies, it seems they are all over the 50 level, which indicates some further increases in prices. However, this trend could easily be countered by OPEC and US shale oil production, if the second half of 2018 sees significant increases in production.
How might all this affect the oil price?
If the current reduction in production by OPEC and non-OPEC supporting countries remains in place, the current trend of reducing stock levels could continue and drive the upward direction of prices. Nearly all the reported stock levels for China, the US, Japan and ARA are below the levels reported in 2016.
On the other hand, we could see a further increase in US shale oil production, and then an attempt by OPEC to stop it by increasing their production, increasing stock levels and driving down prices. We have seen some OPEC members making it clear that $70.00bbl is not where they would like prices to be, and there could well be corrective action in terms of more supply to lower prices and stop the shale march we are seeing in the US.
An uncertain outlook
Coming in on the back of the last three years, where the oil market has endured challenging times, it is inevitable that traders are wary of where the market is heading. As mentioned, the OPEC decision to pull back on output has had more than the desired effect, driving oil prices higher than expected at a time when global demand has been growing. However, many analysts believe that the current prices can’t be supported by the current fundamentals and the bubble may well burst.
Summing up the fundamentals as we progress through 2018, it seems it will be business as usual. All eyes are focused on shale oil production in the US, and the ongoing production cuts by OPEC and non-OPEC supporting countries, as well as the outcome of the OPEC meeting in June. That meeting could be the driver for future price direction, as it is unlikely that OPEC will allow the US to become over dominant in terms of production.
If I were a betting man, which I am not, I would say that prices in 2018 will stay roughly around where they are today, with some slight increases as we go through the year. However, to come back to where I started - the only thing certain about future oil prices is the uncertainty of future oil prices.
