Saudi Arabia and Iran’s Crude Oil Price War
The price of Crude Oil has stabilized around the Key level of 50 bbl, which is the OPEC target for the end of Y 2016. Disruptions of production in several countries, including Libya, Nigeria and Venezuela, and the anticipated higher Summer demand in the United States have reduced some excess supply in the market.
This may not be the end of the downward trend just yet.
Four Key factors could push Crude Oil price down in the months ahead, as follows:
- The price war between Saudi Arabia and Iran is still going on in order to regain market share. Compared to June 2014, monthly production in Saudi Arabia increased by 4.2% while that of Iran rose 13%. Despite official statements, there is no appeasement between the 2 countries regarding the issue of Crude Oil production. After cutting the price for the Asian market, Saudi Arabia then decided to cut it for the European market last week on Iran production ramp-up. The competition between the 2 countries will intensify and could even last once Iran has reached its year-end production target. Notably: Near term, the market is focused on Iran and Saudi Arabia but long term, the increase in Iraqi production poses the greatest risk for the market. Compared to June 2014, monthly production from the country experienced the largest increase among all the Oil producing countries, jumping around 32%. In the years ahead, the increase in production is likely to intensify despite persistent geopolitical risk in the region.
- OPEC cannot afford that Oil price jumps durably above the threshold of 55-60 bbl. From this level, the US Shale Oil operators are again profitable and will be able to flood the market with their production in the space of a few weeks. In just 2 years, impressive technical progress has been made allowing some tight Oil reservoirs located in South Dakota to be profitable even at 20-25 a bbl. OPEC is fully aware that it cannot win the War against Shale Oil. Its development is inexorable, especially because it is essential to ensure US energy independence. But, the cartel can prevent as much time as possible the return of Shale Oil operators in the market in order to enable OPEC members to reduce their dependence on Oil revenue. Therefore, in no case may the price of Crude Oil reach 60 bbl in the coming Quarters.
- Historically, there is a negative correlation between the USD and Crude Oil. When the Buck strengthens in the Forex market, Crude Oil prices fall and vice versa. The process of normalization of the US monetary policy started last December should accentuate the value of the USD. There may still be 1 rate increase from the US Fed this year. Investors, I believe, have already partly priced this outcome. In May, the USD recorded its biggest monthly gainer in 2 years against its 10 peers. The exchange rate of the USD rose 3.7%. In a world where the returns are low almost everywhere, the US economy represents an attractive investment opportunity. Consequently, the global demand for USDs increases, which accentuates the exchange rate of the Buck and pushes Crude Oil prices down.
- The evolution of real commodity prices can be explained by Super-cycles mostly determined by economic growth, technological innovations and demography. Since the industrial revolution of the 19th Century, there has been 4 Super-cycles that lasted usually between 30 and 50 years. Each Super-cycle is composed of a Bull Market and a Bear Market. The current Super-cycle peaked in Y’s 2008-2011 in the aftermath of the global financial crisis. Since then, a Bearish trend has started that could last at least until Y’s 2022-2025 according to industry forecasting models.
The last several months action confirmed that it is almost impossible to predict accurately the price of Crude Oil. Even the most famous industry analysts got it wrong.
However, the probability is very high that Oil’s price will remain low in the coming years. High Crude Oil price is now in the scrapbook. Things actually do return to normal. From Y 1861 to today, the average real price of Crude Oil was 33.90 bbl. The anomaly is not the current frame, but that of Y’s 2011-2014 when the price was around 100 bbl.
|HeffX-LTN Analysis for OIL:||Overall||Short||Intermediate||Long|
|Bullish (0.30)||Neutral (0.11)||Very Bullish (0.56)||Neutral (0.24)|
By Christopher Dembik, Head of Macro Analysis at Saxo Bank
Paul Ebeling, Editor