Written By: Miles Pearson – Forex Focus
An analysis of some of the key events leading to the recent rally in crude-oil prices
Crude-oil prices have spiked more than 22 percent in the last three months to their highest level in more than three years, with prices of light, sweet crude scaling $66 in January for the first time since December 2014, as geopolitical tensions in the Middle East continued to escalate and a sharp decline in inventories within the OECD (Organisation for Economic Co-operation and Development) countries added to the recent rally. In spite of prices stabilizing somewhat, there remains an uneasy calm as countries from OPEC (Organization of the Petroleum Exporting Countries) battle with shale producers in the United States for market share.
There are also a number of other reasons for the recent rally in crude-oil prices, which can be categorised into fundamental and technical opinions. Let’s look at them one by one and analyse how far the rally is likely to extend.
Rebound in the global economy. Economic recovery generally rides on the back of consumption spending as job growth leads to higher consumer outlay. The recent gross domestic product (GDP) numbers from most of the economies across the world point to higher growth during the last few quarters. The automobile sector has been one of the biggest beneficiaries of the rise in employment levels, with most countries reporting higher auto-sales numbers, which in turn reflect in greater demand for petroleum products such as gasoline. The fallout is a larger demand for crude leading to an uptick in prices.
Turmoil in the Middle East. The political mayhem involving the royals of Saudi Arabia in November of last year led to a steep rally in crude-oil prices. WTI (West Texas Intermediate) crude, which until then was trading at about $50 a barrel, surged about 20 percent in one month following the crisis. Added to that was the sudden resignation of the Lebanese prime minister, Saad al-Hariri, following the Saudi crisis and threats by US President Donald Trump to pull out of the Iran nuclear deal, all driving geopolitical uncertainty in the Middle East to new horizons and holding up crude prices at multi-year highs.
Production cuts by OPEC. The Organization of the Petroleum Exporting Countries in association with Russia agreed to scale oil production in November 2016. The 1.2-1.8 million-barrels-per-day cut in output, which was enforced from January 2017 in response to a sharp fall in crude-oil prices that hovered around $40 per barrel in late November, had some effect in driving prices higher. Late last year, OPEC and non-OPEC members, which together account for more than 40 percent of global crude-oil supplies, agreed to further extend output cuts until the end of 2018, with the option for an early exit from the deal if prices rose rapidly.
US exports. For decades, prices of crude oil have been determined by markets outside the US, in spite of the country being the largest consumer and importer by a long, long way. Although crude oil is produced within the country, it was generally meant for domestic consumption, and the US has never been an exporter of crude—until recently, when the US Congress permitted shale-oil producers to export locally produced crude to global markets. With potentially huge reserves, the country’s production and exports are having a direct influence on international prices, which had been largely the domain of the OPEC countries.
Correlation with the US dollar. Most of the crude-oil contracts traded globally are priced in US dollars. Overlooking all the other parameters, with the exception of the exchange rate, a stronger greenback should principally lead to a fall in crude-oil prices, and vice versa. From January 2017, the greenback represented by the dollar index has dropped about 15 percent, while crude-oil prices surged around 20 percent, more or less in line with historical stats.
On the charts, WTI crude has been in an uptrend since March 2016, when it broke out of its long-term bearish channel at $38 per barrel. Crude prices that tested $26 the previous month reversed losses to top $50 in early June 2016. Since then, prices have been oscillating in a tight $10 band, between $45-55 per barrel for more than a year, before breaking out last November to settle at around $65 in January of this year. Although the broader uptrend remains intact, in the near-term WTI is likely to face stiff trendline resistances at around $67-68 with key supports at $64 followed by $61-62. However, a break of the near-term resistances should extend the current gains to the top end of the long-term bullish channel at $72.
Oil producers across OPEC and Russia are up against their US counterparts to gain market share. While shale producers in the US essentially require oil prices to remain at around the $50-per-barrel region to cover their production costs and the high-yield bonds used for financing, OPEC will do all it can to ensure that oil prices are tightly balanced, thereby discouraging additional entrants into the market, as they have already seen their market share dwindle in the wake of US crude-oil producers.
A majority of analysts are also cautious that the recent gains may not last long as shale producers in the US are ramping up production in the wake of rising prices while locking in prices in the derivatives market. According to an annual survey of energy professionals by Reuters, the number of respondents expecting crude-oil prices to fall below $50 in 2018 slipped to 15 percent from 37 percent a year earlier, although a majority of them expect prices to remain around $70 until the end of this decade.