Mises Wire

Are Crude Oil Prices Becoming Immune to Geopolitics?

Oil seems immune to what in the past — artificially, effectively and quickly — caused a surge in its prices.  Recent OPEC cuts have had little (or no) effect on the market. The sanctions from Saudi Arabia (and other countries in the Persian Gulf) on Qatar were barely noticed. Unlike all NYSE indexes, that show a steady post-crisis growth, crude oil benchmarks have not taken off, showing a bear market behavior. Forecasting trends and prices brings up an important question: Will geopolitics alone be able to influence the oil and gas market as it did in the past?

We may be witnessing a more realistic version of the market taking over — the invisible hand in action. New players have a bigger stake on the oil industry, thus the power to influence oil prices is scattered among a larger number of parties rather than a cartel and its allies (as it was in the past with OPEC). The result is that a single action (i.e., cutting oil production) does not have a large effect on the global oil market, because there are other “forces” playing a role almost just as big in the commodity’s overall supply and demand. Perhaps we are approaching to a period of steadier values — i.e., “lower for (much) longer.” Don’t get me wrong, I am not suggesting that the trends will be easier to predict, but that it may be more difficult for a single party to artificially influence prices.

One thing to watch closely is the current glut and the storage capacity, which is likely what has driven not only the market but also OPEC’s decisions in the last years. Russia has agreed to follow Saudi cuts in a hopes of reducing their current stock and rising crude prices, but the market has showed the opposite. The glut alone is far from being the main price driver. There are two main non-OPEC actors that also play an important role.       

China’s Slowdown

China’s energy consumption plays a major role in the global economy. According to BP’s Statistical Review of World Energy, China’s total energy consumption increased less than 2% YoY in the last two years (2015, 2016) and its GDP annual growth rate in 2016 (6.79%) was lower than that one in 2015 (6.9%). Oil consumption shows a rather low increase (3%), half of what the country’s oil demand was for the previous year (6.9%).

Infrastructure plans might be seriously jeopardized, amid corruption scandals and a huge debt. All big infrastructure projects (planned, designed and executed by the Chinese communist party) seem to honor the motto “build it and they will come.” According to a study conducted by the University of Oxford, “fewer than a third of the 65 Chinese highway and rail projects he examined were genuinely economically productive, while the rest contributed more to debt than to transportation needs.” With a null return on such big spending, China keeps adding debt to their economy (more debt in the first nine months of 2017 than the US, Japan and the EU combined.). Another global crisis may be on the verge. China, with its demand for energy and its economic policies, is a major external player in the oil and gas market prices.

US: Leading Oil Production, Optimizing Fracking, Withdrawing from the Paris Accord

Unlike China, the United States (a non-OPEC country) does not have the Federal Government playing a big role (by international standards) in the domestic oil and gas market. This is even moreso since the export ban was lifted in 2015. This nation is leading the world oil’s production for the third year in a row; a direct hit on OPEC’s further plans on cutting production. Higher prices (if supply reduction is strong enough to rise them) will mean a bigger market share for the current US shale oil and gas industry, where some producers have managed to run the business with lower costs (an incentive created by the low oil prices).  Activity is already showing positive numbers, the US oil rig count has increased for the first time in the last two years.

No less important is Trump’s decision to withdraw from the Paris Climate Agreement, perhaps a breath for the oil and gas industry — at least at a domestic level-. The country has no obligation to impose “green” taxes on fossil fuels; this avoids an artificial, negative effect on oil, gas and coal demand, thus keeping prices free to change with the market.  This particular topic should not be isolated from the expected corporate tax cuts (to be approved by Congress), because that might create incentives for investing in technology, targeting a new reduction in production costs. The growth of renewable energy will still depend on subsidies –if current demand of such energy remains unchanged–, but they will not come from taxes on oil, at least temporarily.  The actual destination of those extra bucks in the investor’s pockets will depend on the decisions made by shareholders on the corporate boards.

Crude prices have not soared, let alone showed a significant increase in the last three years. The big glut is still driving some geopolitical decisions, but there are other factors, powerful enough to spontaneously challenge the market. With supply and demand not influenced by geopolitics anymore, the oil and gas markets might soon be free or at least strong enough to overcome the remaining political intervention.

How crude prices react with upcoming events (i.e., Aramco IPO, future OPEC’s cuts, India and South America development, etc.) will tell us whether the power is still held by a (new) cartel or not. Meanwhile, longer periods of price stability are good news to consumers and so are they for the industry.

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