Why Is The Oil Price On A Rollercoaster
This year has seen oil prices hit dizzying peaks followed by alarming troughs. What’s behind this rollercoaster for oil prices?
The Highs
In the summer of 2018, global oil prices reached unfamiliar heights.
By the start of October, they were at a four-year high, with Brent crude selling for $87 per barrel and US crude nearly $77. This threatened higher prices for drivers and economic challenges for central banks.
There were several factors behind this.
In the long term, oil highs and lows are prone to exaggeration. Given the high stakes and high profits associated with this commodity, speculative investors are heavily involved.
Their hopes and fears drive the highs higher and the lows lower.
In the medium term, the recent spike was driven by an agreement between the Organisation of Petroleum Exporting Countries (OPEC), Russia, and other oil producers.
In January 2017, they started capping oil output to tackle a previous price downturn. Lower production increased the price of oil.
Then came the immediate causes. Most important was the threat of US sanctions on Iran, which produces around 4% of global oil. This high-profile event created a fear of scarcity, pushing up oil futures.
Political and economic crises in Venezuela hit production there, as workers left troubled jobs and the government struggled to maintain the industry. Then summer came, marking peak driving season in the US, pushing up demand from oil’s biggest consumers.
The Lows
As prices surged, analysts said that they were unsustainable, and this quickly proved correct. In October, investors started dumping oil assets. A harsh price correction kicked in, thanks to the same exaggerating factors that influenced the rise.
Prices fell over 20% in two months as sell-offs turned into a rout. Again, this was driven by several factors.
Firstly, there was OPEC. The organisation doesn’t want high prices too high, as this would push consumers towards alternative energy sources.
OPEC and its allies agreed in June to raise output again, increasing supply. US oil production had been rising over the past decade thanks to shale oil, while Russian production hit post-Soviet highs, and together these created the promise of a glut.
Secondly, demand was weaker than expected. In October, OPEC and the International Energy Agency made lower predictions for oil consumption, thanks to a slowing global economy.
The rising strength of the US dollar made prices even higher for buyers in countries such as India, Turkey, and Indonesia, reducing demand there.
Meanwhile, cracks appeared in the sanctions against Iran.
It became clear that the EU would not cooperate with Trump’s policy, while the US itself agreed to let eight countries keep importing oil from Iran for six months. Supply from Iran was not going to be hit as hard as had been feared.
The Key Factors
Such price swings are familiar to long-term oil watchers. They highlight the key factors currently affecting oil.
OPEC is critical. It wants to maintain high enough prices for a good profit while not deterring consumers. It can afford to let prices drop relatively low for short-term strategic purposes without losing money.
One such purpose would be to undermine US shale oil production. The growth of shale oil has significantly expanded US production, pushing prices down, but shale producers can’t let them drop too low, thanks to obligations to financiers.
Trump, the populist president, favours high production and low prices because it makes consumers happy. American policy is likely to reflect this for at least two more years.
Exchange rates have an impact. With oil prices pegged to the dollar, demand from emerging economies is likely to drop when the dollar is strong.
Russia is important, and not just because of its increased production.
The Saudi and Russian energy ministers are reportedly working closely together, and Putin’s government will use whatever tools it can to undermine international opponents.
As long as OPEC and US oil interests are in conflict, Russia is likely to side with OPEC and so increase its impact.
And then there are those market exaggerations caused by speculative investors, ensuring that any trend becomes a dramatic price swing, whether up or down.
What Next for Oil?
Dramatic swings in oil prices are nothing new – as recently as 2014, they dropped 40% in seven months. So will current trends continue or will we see an upswing again?
Trump and Russia both seem to favour high production, which would keep prices down. But OPEC is considering cuts in production again, and Russia is likely to go along with this.
At the very least, this would stabilise prices, though it might take months to have an impact.
Given the erratic character of Trump’s policy-making, it’s hard to tell what his Iran sanctions will do.
His move towards protectionism may become more important, as it slows the global economy, reducing demand from emerging nations.
The fall in prices could add to social and political trouble in economies dependent on oil, like Nigeria and Venezuela. Of course, such disruption would lead to lower supply, raising prices again.
This is the nature of oil prices. Every upward driver comes with an associated downward one, whether it’s shifts in OPEC policy, the interests of US shale producers, or the policies of the Trump administration.
The current downswing may last a while, but an upswing will follow soon enough. Nothing will stop the wild ups and downs of this particular rollercoaster.
Paul Connolly
Paul Connolly has been a journalist for more than 20 years, as a reporter and editor for Argus Media, Reuters, The Times, Associated Newspapers and The Guardian. He has covered Islamic Finance for Reuters in the 1990s. Paul has since helped launch three newspapers, as well as reported from Tokyo, Los Angeles and Stockholm.
