There has been a plethora of headlines lately regarding the most recent appreciation in oil prices. While the recent pull back has left oil at around $65 per barrel, this commodity had 7.5% increase in the first quarter of 2018 and has more than doubled since the trough in 2016! We at APCM thought it would be beneficial to add some color as to what is driving this movement.
We’ll examine three catalysts identified in a recent World Bank report on the topic: robust demand, production restraints, and geopolitical tensions. Let’s get drilling!
Robust Global Demand
The synchronized global expansion that began in 2016 has created a broad and robust demand that has helped pull oil prices higher. For instance, the World Bank has stated this demand has had, “…a significant role in the latter half of 2017 and early 2018. …Global demand for crude has been strong, with an increase of 1.6 mb/d in [the first quarter of 2018] relative to a year earlier.” However, global demand for crude oil has remained fairly consistent at about 1.6% annual growth over the last 20 years, as illustrated in the chart below, so we know that there must be other factors impacting prices.
OPEC and Production Restraints
The Organization of the Petroleum Exporting Countries (OPEC) is a cartel made up of various member countries that agree on the amount of oil they produce to influence global oil prices. According to the US Energy Information Administration, OPEC’s combined rate of oil production equaled 44% of total global output for 2016 – so you can begin to see how much sway they have in determining oil prices.
As the World Economic Forum describes, back in 2016, OPEC’s output increased as the United States and allies entered into the Joint Comprehensive Plan of Action (JCPA), lifting sanctions off Iran and allowing their oil to hit global markets. This, along with domestic production from U.S. shale at the time, created an oil glut that persisted until just last year. Spurred on by hurting member states who needed higher prices for fiscal budgets, OPEC began agreements in early 2017 to cut production, shrink the glut, and raise prices again. As the two charts below illustrate, surprisingly compliant cooperation over the past year has reduced total inventories and has also exceeded their agreed cutting levels. As supply decreases, prices increase. This is the first contributor to oil price movements.
Unlike the voluntary output cuts that OPEC members can agree to, there are also endogenous supply shocks that can occur in the form of geopolitical risks. Venezuela is a prime example. U.S. sanctions, crumbling infrastructure, and a looming national debt has caused Venezuela to continue a 6-year long decline in oil production, as stated by Reuters. OPEC’s website reports that Venezuela sits on one of the largest oil reserves in the world and relies on oil for 95% of their export earnings. Yet despite this, the country’s state-owned oil company, PDVSA, cannot properly function amidst internal instability. This has caused Venezuela to overshoot their pledged production cuts and create a large, involuntary decrease in supply.
Iran is in the same boat, as the U.S. exited the JCPA and increased sanctions just last month. Although the sanctions don’t take effect until August, the market is still digesting what the real implications of this may be. This short-term uncertainty, however, is adding a risk premium to the outlook of oil prices.
Navigating the Oil Field
APCM’s experienced team offers a “well“spring of combined investment knowledge and monitors the risk and return characteristics of commodities to help you take advantage of this asset class according to your risk tolerance.
World Bank Global Monthly, May 2018: http://pubdocs.worldbank.org/en/600711527631271901/Global-Monthly-May18.pdf