Moneycontrol
Last Updated : Sep 06, 2018 03:57 PM IST | Source: Moneycontrol.com

What’s brewing in the oil world?

A plethora of factors like trade wars, weather anomalies in the US, inability of nations to boost production have inundated a negative sentiment, leading to the firing up of oil prices

Ruchi Agrawal @ruchiagrawal

Animosities in trade relations, coupled with uncertainty around Hurricane Gordon, have led to re-firming of crude oil price to $79 per barrel. Internal issues within major oil exporting countries are also contributing to the firming up of oil prices.

This high volatility mimics rapidly fluctuating sentiments, with changes in geo-political environment and the short lived but strong impact of news flows.

Hurricane Gordon

Hurricane Gordon led to precautionary closure of rigs around the Gulf of Mexico. With uncertainty around the probable impact on supply from the region, crude oil prices saw substantial uptick in the last few trading sessions, with Brent crossing the $79 per barrel mark. Latest news updates indicate that the hurricane is a mild one and has diverted eastwards, providing some relief from the panic.

September is notoriously popular for hurricanes in the US and threat of the same continues. After this, winters, which sees a surge in demand, would kick in, thereby providing support to crude prices.

US-led trade wars and Mexico deal

US President Donald Trump’s arm-twisting actions have stirred up immense trouble in oil markets and have brought volatility to global macros. After threats of strong sanctions on Iran, the US softened its stance, indicating room for negotiations on a case-by-case basis.

The US is now in talks for a new trade deal with Mexico to replace the North American Free Trade Agreement (NAFTA) and has announced its intentions to go ahead with the deal, with or without Canada. Despite talks, both parties have not come to a conclusion yet, and a final take on the deal would be worth watching out for. Amid brewing trade war tensions, a renewed trilateral deal between the nations would be a positive, which could help soften crude prices.

Iran is not giving up easily

While the US announced a unilateral exit from the nuclear agreement in May, other European nations still remain a part of the deal. Iran is now pushing European partners to provide written guarantees for upcoming demand as per the agreement.

The Organisation of Petroleum Exporting Countries (OPEC) and allies had agreed two months ago to increase oil production, but they didn’t detail how the production increase would be split between OPEC and non-OPEC nations. A committee of OPEC and allies is scheduled to meet in Algeria next month to discuss allocations.

Iran has been actively opposing reallocation of its oil production share to other OPEC partners and has been threatening consequences, varying from price wars to closing down the Strait of Hormuz, which is a strategic route for crude oil trade from the Middle East. Though Iran has made similar threats in the past, it was never implemented, but what the future holds is still to be seen. A price war between Saudi Arabia and Iran could effectively put an end to OPEC.

Amid all this, Iranian oil production has seen a sharp dip going below the 1 million bpd mark in August from the 2.3 million bpd a month before.

What is happening in Venezuela?

Crisis stuck Venezuela has seen rapidly shrinking oil production and exports, which have dropped by half since 2016 to below 1 million bpd. To support tumbling output, Venezuela’s state-run oil firm PDVSA has signed a $430 million investment agreement to increase production by 640,000 bpd at 14 oil fields. Given the country’s political and economic instability, there are doubts whether this investment would go through.

Reserve production capacity in Iraq

Political dispute between the central government and the Kurds in Iraq led to lower output (by almost 300,000 bpd) since last year. Iraq has since been sitting on this reserve capacity and has lately indicated plans for a production boost. While there has been a substantial uptick in overall production from Iraq in August, it is still to be seen how much of it could re-enter the system, given the recent exit of Royal Dutch Shell from one of the country’s biggest oil projects.

India and China’s stance on US sanctions

India and China have taken a stance for continuing import of Iranian crude. While China took a strong stance against US sanctions, India suggested a soft stance and said it will try to comply with US sanctions. However, it has allowed refiners to continue importing Iranian crude, but how much of it would be implementable remains to be seen as banks funding the import (like State Bank of India) and import insurers back out from the deals during the sanction period.

A depreciating rupee and yuan against the dollar are making retail fuels more expensive, which could lead to slowdown in demand growth from these nations. China is also facing heat from a trade war, which could lower incremental demand.

Impact on India

The uptick in prices has become a burden for domestic refiners on one hand and is increasing the risk of subsidy burden sharing for domestic upstream oil companies. High oil prices brings added pressure for chemical and agrochemical companies. It adversely impacts profitability of tile, consumer staples, logistics, paints, dyes, plastics, pipes, luggage and airlines in the form of higher input cost. While some of these companies might be able to pass on higher costs, others might take a hit on margins. Higher crude also brings in added pressure on governments’ budget, impacts the fiscal math and currency because of the widening current account deficit.

Outlook

A plethora of factors like trade wars, weather anomalies in the US, inability of nations to boost production have inundated a negative sentiment, leading to the firing up of oil prices. A genuine slowdown in demand growth for oil or an uptick in supply from oil producing nations would be factors which could provide some price relief. However, a demand slowdown would essentially mean sluggish economic growth in global economies and might have its own repercussions. All eyes would be on the upcoming meeting of OPEC nations and allies, which could carve future production trends.

Very high crude levels is not sustainable as more and more producers get on board the supply ship. The upcoming hurricane season in the US, winter uptick in demand, uncertainties in the geopolitical scene and bottlenecks to production growth are some of the factors that would dictate price contours in the future.

Follow @Ruchiagrawal

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First Published on Sep 6, 2018 03:57 pm
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