Big Picture. Oil — where is Mr Fickle headed in 2019?

Just about four months back, the spectre of rapidly rising oil prices threatened to throw India’s macros out of shape. In early October 2018, global crude oil (Brent) had shot up to $85 a barrel, nearly doubling from $45 a barrel in June 2017. This was a major reason for the rout of the rupee to 74 a dollar. For a country that depends on imports to meet more than 80 per cent of its crude oil needs, a spike in the fuel’s price means higher import bills and higher current account deficit.

But in less than three months, the scenario changed for the better. Rather than continuing its rise to $100 a barrel or more as many analysts had been predicting, oil reversed course, and how. It fell all the way back to below $50 a barrel by end-December 2018. Not surprisingly, the rupee recovered to about 70 a dollar. But notoriously fickle as it is, oil has been rearing its head again and now hovers around $60 a barrel. Where is the fuel headed in 2019? Trying to forecast oil’s movement has always been a mug’s game, with multiple global factors, uncertainties and speculative forces at play. That said, an idea of the factors moving the see-saw over the past few months could give some pointers on the direction ahead.

Why the rise…

The sharp rally from June 2017 to October 2018 was driven by several factors. One, the output-cut deal between OPEC (Organisation of the Petroleum Exporting Countries) and some major non-OPEC players, including Russia, finally showed results and squeezed out much of the excess oil inventory in the market. Two, the economic meltdown in Venezuela — a key oil exporter — resulted in a sharp cut in the country’s oil production. Third and, most importantly, the US, under Donald Trump, pulled out of the Obama-led nuclear deal with Iran and re-imposed economic sanctions on the major exporter. Oil exports from Iran, which had picked up in 2016 and 2017 after the nuclear deal, had fallen in the run-up to the sanctions that were to take full effect from November 4. There were apprehensions that about one million barrels per day or more could be lost from supplies once the Iran sanctions took full effect — that’s about 1 per cent of the global consumption.

...the fall..

But even then, there were factors that could have capped oil’s rally. One, unlike earlier, the Iran sanctions this time around were largely a solo US show with the European Union (EU) nations not on board. Many nations were looking at alternative arrangements to work-around the US sanctions and continue importing oil from Iran; this would have meant lower supply disruptions than expected.

Two, the US was putting pressure on OPEC (primarily on Saudi Arabia, the key oil producer and US’ geopolitical ally) and other major oil producers to moderate oil prices by stepping up output and making up for the shortfall that was expected to arise from Iran sanctions. There were indications that Saudi Arabia and Russia had agreed to increase output.

The fact that the Saudi government was under intense international diplomatic pressure from the fallout of Saudi journalist Jamal Khashoggi’s gruesome murder in Istanbul is also said to have played a part in their playing along with Trump’s demand to increase oil output. Besides, the US shale oil industry had been sharply stepping up its output in response to high global oil prices. This output was not finding its way to the international market due to infrastructure and transport bottlenecks in the country, but this problem would have been resolved sooner or later. Then, there were growing worries about the impact of the US-China trade war; marked escalations in this wrestling among the heavyweights could certainly dent the global economy, oil demand and prices.

In this cocktail of uncertainties, what decisively tilted the scales against oil prices was Trump’s decision to grant waivers for 180 days from the Iran oil import sanctions to eight countries, including major importers such as China and India — the eight countries are said to account for about 80 per cent of Iran’s oil exports. This decision to largely maintain status quo for the time being — speculated upon but announced just days before the November 4 deadline — assuaged concerns about a major supply squeeze shock and pushed oil firmly down the slippery slope to under $50 a barrel. The oil bulls found themselves caught on the wrong foot by this turn of events.

...and the ascent again

The response from OPEC and other major oil producers such as Russia to such rapid, sharp price cuts was inevitable. It came in their December meeting decision to cut oil output by a steep 1.2 million barrels a day from January 2019 for the first six months of the year. This, along with what seems like a thaw in the US-China trade war, has helped oil recoup a good portion of its lost ground in January; at about $62 a barrel, it’s up 25 per cent from its December lows.

Range-bound

Amidst all these pulls, pushes and imponderables, one could hazard a guess that oil could be in the Goldilocks range of $60-$70 a barrel in 2019 — not too low, not too high. Oil seems unlikely to fall too sharply ala 2016 and 2017. One, the waiver for eight countries from the Iran oil import sanctions is temporary; it remains to be seen how this plays out around early May 2019 when the waiver ends. Imposition of full sanctions or even tightening of the waivers could see oil prices rise. Next, the oil output cuts in force now by OPEC, Russia and others may put a floor on oil prices. The recent US sanctions on Venezuelan oil could also support prices.

At the same time, oil prices are also unlikely to hit the $85 a barrel levels seen last year. One, the global economy does not seem to be in great shape and this could mean subdued demand growth for oil in 2019. An escalation of the US-China trade war should hurt demand further and put a cap on prices. Next, a sharp rise in global oil prices rise could see a ramp-up in US shale oil exports. Also, at very high price levels, even high-cost global producers will find it viable to produce. Besides, demand destruction could kick in at very high price levels, as seen in the past. Finally, the imperative to keep fuel prices at US pumps at reasonable levels could again see Trump adopting realpolitik on the Iran sanctions — more rhetoric and less action.

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