Since the beginning of the 2017 the oil market has fluctuated around the $50 per barrel, with the WTI ranging from $54 to $42 and the Brent from $58 to $45. In the last few years the market has been shaken by many major events. We remind here the coming back of Iranian crude and the recent Qatar crisis.
In 2014 the oil prices dropped more then 40% in few months. What contributed to the collapse is a mix of factors, but two are the most significant. First of all, the slowdown of many emerging economies like Russia, Brasil, India and China. China in particular is a huge market and its demand has a big impact on oil prices. At the same time Canada and United States raised their oil production, with the U.S. private companies which began to use the fracking technology to extract the shale oil. Lastly, is good to remember that Riyadh decided to not cut its production and left the prices go up. Saudi Arabia has the biggest oil reserve in the world and it can produce oil at low prices. This is why the Arab country can survive with low oil prices for some years. But not for too long.
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The variables to monitor for the oil market
Here I will list the variables to watch, which in my opinion are most significant for the short and middle-term.
Riyadh’s budget crisis
Riyadh’s economy rely on oil too much. That’s why once Tehran was free to flex its oil muscles and the prices dropped near a $20 low the Arab monarchy began to worry. Low oil prices and the costs for the Yemen war putted under pressure the Kingdom’s budget.
In 2015 the deficit reached a deficit record of nearly $100bn and the Kingdom had to introduce measures to ease the budget. So in the following year, in 2016, the government launched an austerity drive to cut the public spending. The unprecedented measures touched the whole Kingdom society. State workers sustained a cut of their salaries and lost many benefits. The salary of ministers dropped by 20% and Shura members faced a cut of 15%. In addiction, the government reduced the subsidies on energy and water.
In the same period the Crown Prince Mohammed bin Salman presented Vision 2030. Vision 2030 is a plan which tells how Saudi Arabia should become less oil dependent. So, in the next years Riyadh will be busy to diversify its economy and to ease the deficit.
In November 2016, during the 171st OPEC meeting, Saudi Arabia agreed to cut the oil production along with other cartel’s members. Since then the prices are stable around the $50 per barrel.
There are many reasons to think that the prices will not stand at those levels. Despite the recent OPEC’s cut, the output levels are still high. The market is full of oil and the offer could even rise in the future.
The Chinese effect
China’s demand has a consistent effect on the oil market. The country is in the middle of a structural transition that we should monitor with attention. In an attempt to switch from external to domestic demand many sectors will be shaken. The service sector is becoming dominant while the deindustrialization continues. China looks more and more modern each passing year and it seems to have dodged the collapse announced by many in 2015.
The effects of this transition remain mixed and Beijing has still a lot work to do. People interested to elaborate the subject can read this good paper from IMF. For now we can say this: the thirst of oil from China will be stable for years.
There is another important aspect which many don’t consider. In the last 10 years Beijing has accumulated a big oil reserve. As Irina Slav writes on oilprice.com, the reserve could possibly store more then 680 million barrels, exceeding the U.S. SPR. The rise of oil’s demand in 2016 and in the first half of 2017 could be just an attempt to increase the reserve. But as the reserve grows, the demand’s rate could soon start to decline. This would put oil’s prices under pressure and push them to the bottom.
The U.S. shale oil’s buffer function
The U.S. shale oil works as a buffer function for the oil market as it prevents the prices to rise too much. The fracking technology makes oil’s extraction cost-effective only above certain levels. When the prices start to rise over $60 per barrels the U.S. companies floods the market with shale oil. For this reason it will be difficult to see prices at $100 per barrels again in the short or middle-term.
The Qatar’s crisis
In June 2017 several countries in the Gulf region cut their ties with Qatar. The move was lead by Saudi Arabia and was followed by Egypt, United Arab Emirates and Bahrain. The Saudi-led coalition blamed Qatar to support the terrorism and decided to isolate Doha. This is the official narrative. But the truth behind the move could be political and strategical. Riyadh may also being punish Doha for the recent rapprochement towards Tehran.
Doha it’s an important business hub for the world and its isolation could put at risk billions of money. Qatar alone is responsible for almost the whole gas furniture in United Kingdom, while Europe is a top destination for the Doha’s cash. That’s why many started to worry for the consequences of this diplomatic incident.
For now Doha has been able to protect its investments and to keep its foreign relations. Nevertheless, it is difficult to forecast what will really happen. The Gulf crisis may have a long-term consequences on both Qatar and other Arab countries. In the short-term it could have an impact on the OPEC’s deal, which is already very fragile. Is quite likely that the deal will not be renewed and the oil output will rise. This, of course, will put oil’s prices under a downward pressure.
What the technical analysis can tell us on the Oil market
Oil prices are on the rise since the beginning of 2016. The bullish trend resumed after a low of $27 per barrel. This happened much earlier then the OPEC decision to cut the production. This stresses that self-correction mechanisms were already in play in the oil market. Indeed, oil prices were so low that many U.S. companies decided to shut down the production. Terrorist attacks in countries like Nigeria forced the production to slow down. Actually, as we can see on the chart, the OPEC deal has done little to support the prices.
Let’s now focus on the WTI’s monthly chart. We can recognise two patterns on this chart: an inverted cup with handle; an ascending triangle. This latter pattern is more clear on the daily chart (below here).
Usually the inverted cup with handle is a pattern that leads to a bearish market. We will have a first confirmation of a downward move with the breakdown of the uptrend line. This will push the prices towards the 2015’s low, near the $25 barrel per day. If this level will be broken is quite possible to see the prices going to test the $20 per barrel and then the $15 per barrel.
Otherwise, if prices would breakup upward the ascending triangle we will see a test of the 70$ per barrel. However, the actual scenario makes think that the former case is more likely to happen.
Low oil prices could increase the instability in the Middle East
If this will really be the case, oil-producing countries will be under pressure. Saudi Arabia is in the middle of a difficult transition and its internal troubles will increase the instability in the Middle East. At that point it’is not impossible that the prices will skyrocket again. But of course, here I’m just speculating.
In the long run, it’s very very difficult to forecast what will really happen in the oil market. We will see how things will evolve in the next months.