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Here is why crude oil prices continue to rise even when global growth forecasts are cut

The prices of crude oil continue to increase as it is influenced by several covert and overt factors that economies across the world leverage to their advantage.

November 06, 2018 / 02:17 PM IST
Speculation and Market sentiment | Speculation, and the use of market instruments such as hedging, lead to a spike or dip in prices. Brent crude is the benchmark for global oil prices, whereas Western Texas Intermediate (WTI) crude is another benchmark for oil futures that is focused on North America. A difference between the spot prices and the future prices reflects the sentiment of investors. It is for this reason that oil prices hit a four-year high of $86.74 a barrel earlier in October, as the market grapples with the expected loss of Iranian exports due to the US sanctions. (Image: Reuters)

Speculation and Market sentiment | Speculation, and the use of market instruments such as hedging, lead to a spike or dip in prices. Brent crude is the benchmark for global oil prices, whereas Western Texas Intermediate (WTI) crude is another benchmark for oil futures that is focused on North America. A difference between the spot prices and the future prices reflects the sentiment of investors. It is for this reason that oil prices hit a four-year high of $86.74 a barrel earlier in October, as the market grapples with the expected loss of Iranian exports due to the US sanctions. (Image: Reuters)


Crude oil prices have kept rising since the beginning of the year, even managing to reach record highs that were last seen in November 2014.

What is surprising is that the rise continues despite the International Monetary Fund’s (IMF) recent downgrade in the global growth forecasts for 2018 and 2019 by 0.2 percentage points to 3.7 percent.

The downgrade was attributed to disruptions in trade policies between members of the European Union (EU) over Brexit, and the ripple effects of the ongoing tariff war between the United States (US) and China.

Yet, the prices of crude oil continue to increase as they are influenced by several covert and overt factors that economies across the world leverage to their advantage.

Also read: How crude oil is traded and why the prices are on the rise

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A key factor that affects the prices is the supply of crude oil in global markets. While most of the world runs on the energy released from burning the black gold, not every country is privileged enough to find a steady supply under its crust. The Organization of the Petroleum Exporting Countries (OPEC) is responsible for about 40 percent of the world’s oil supply and 60 percent of the oil traded globally.

This imbalance in the distribution of oil means that geopolitical events play a big role in its supply and the market sentiment. Iran, the third largest supplier of oil in the OPEC countries, is set to face new round of economic sanctions from November 4 after US President Donald Trump withdrew from the 2015 nuclear accord in May.

The US states that this measure was taken in retaliation to Iran’s possession of nuclear weapons, and its alleged support of terrorist activities. US President Donald Trump has urged the OPEC to raise output to help cover a shortfall due to new US sanctions on Iran.

India imports close to 80 percent of its crude oil demand, and is the largest importer of oil from Iran, followed by China and Turkey.

The other factor that affects oil prices is the market sentiment. Speculation, and the use of market instruments such as hedging, lead to a spike or dip in prices. It is for this reason that oil prices hit a four-year high of $86.74 a barrel earlier in October, as the market grapples with the expected loss of Iranian exports due to the US sanctions.

Also read : Govt says no issues with oil supplies, sentiment hurting price

Brent crude is the benchmark for global oil prices, whereas Western Texas Intermediate (WTI) crude is another benchmark for oil futures that is focused on North America. A difference between the spot prices and the future prices reflects the sentiment of investors.

If Oil Minister Dharmendra Pradhan announces in future that India has secured a waiver from the sanctions imposed by the US, it would continue purchasing crude oil from Iran. This would likely reflect as a dip in the oil prices.

Another factor weighing in on the speculations around the oil prices is the recent disappearance of Saudi journalist Jamal Khashoggi from a Saudi consulate in Istanbul. Khashoggi is a fierce critic of the Saudi Arabia’s policies and administration, with his views aired on the Washington Post’s opinion page.

Allegations made by the Turkish government of Khashoggi’s murder by the Saudi establishment soon surfaced. In light of these updates, many top executives from companies such as Google, Uber, Master Card, HSBC and Credit Suisse bailed out from an investment conference that was to take place in Riyadh.

Even International Monetary Fund (IMF) Managing Director Christine Lagarde has deferred a planned trip to the Middle East. She was reportedly "horrified" by media reports about Khashoggi’s disappearance.

The events led to a support in oil market prices amid growing US tensions with Saudi Arabia. According to a CNBC report, it has stoked fears that Saudi Arabia may reduce its output to raise oil prices further. Of all member countries of OPEC, Saudi Arabia accounts for close to 10 percent of the world’s oil supply. Thus, state-run oil giant Saudi Aramco can throw around its weight if need be, with its public statements on the supply of oil having the power to alter prices.

How does the rise in oil prices affect the stock market?

Aside from a sharp drop in oil prices towards the end of 2014, the two have traced a similar trajectory. A World Bank article attributed the fall to the slowing growth of emerging economies like India, China and Russia from 2010 onwards, leading to a steep drop in demand.

The rising oil price pressures from 2008 also forced countries like the US and Canada to tap into shale oil reserves through fracking. This further reduced the demand on global oil. Finally, OPEC did not intervene by cutting down its supply, as its member countries were of the consensus to produce as many barrels as possible, as reported in the Washington Post.

Brent

Above is a graph plotting the monthly spot prices of Brent crude with the BSE Sensex over a ten year period. It can be clearly seen that the stock markets and crude oil prices generally run in tandem.

A rise in crude oil prices motivates the more affluent of the OPEC nations to use the rise in oil revenues to spur further growth, and commission industries to take on new projects. This sort of spending has a ripple effect on industries across borders, which reflects as gains in the market.

OPEC and its allies including Russia agreed to reduce output by 1.8 million barrels per day (bpd) from the start of 2017 with Moscow pledging to cut some 300,000 bpd.

As oil prices hit $80 per barrel in recent months and with global oil inventories shrinking fast, Saudi Arabia and Russia agreed to ease restrictions although they never said the exact levels they would target. Amid the rising geopolitical tensions, these measures should provide some relief in crude oil prices in the coming  future.

(With inputs from agencies)

(With inputs from Ritesh Presswala)

 
Siddhesh Raut
first published: Oct 18, 2018 01:05 pm

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