Geopolitical tremors mean a choppy outlook for oil in 2019

Get used to more scary oil market volatility in 2019. This is the message coming from leading industry strategists and forecasters after a bruising end to last year, when Brent crude dipped below $50/b.

Although the benchmark has recovered along with major global stock markets, forecasters are concerned about the prospects of a sustained rebound. Unpredictable geopolitical upheavals like Brexit and US President Donald Trump’s trade wars are expected to weigh more heavily on sentiment than the fundamentals of supply and demand.

“One of the key lessons learned in 2018, painfully by some, is that market sentiment can shift violently without much change in fundamentals, requiring a steady, holistic perspective,” said Chris Midgley, global head of analytics, S&P Global Platts. “It is clear that this volatility will remain a feature across the energy markets in 2019.”

Global demand is becoming harder to predict. The world consumed on average a record 100 million barrels per day of crude in 2018 but the positive outlook is being clouded by weaker economic growth. The Paris-based International Energy Agency (IEA), in its final market report of the year, kept its demand growth figure unchanged at 1.4 million b/d, blaming a weakening economy for offsetting the otherwise positive environment for oil consumption caused by weaker prices.

Meanwhile, stockpiles of unwanted crude linger in tanks around the world. Inventories in OECD industrialized economies continued to build in October for a fourth consecutive month by 5.7 million barrels to an ocean of almost 2.9 billion barrels, according to the IEA. The build sent stockpiles above their five-year average for the first time since March.

“Fundamentals in the oil market look bleak, with slowing economic growth and weaker-than-expected demand pushing the market firmly into bear territory,” said Ashley Kelty oil and gas research analyst at Cantor Fitzgerald Europe.

On the supply side, there is also little cause for certainty. Forced on the defensive, OPEC and its allies led by Russia are cutting output by a combined 1.2 million b/d. However, delivering on their pledges may be hard to achieve given the tough economic conditions many members now face.

Saudi Arabia – the world’s largest exporter – requires prices to trade above $80/b to balance its bloated state budget. The kingdom remains locked in a bitter cycle of dependence on oil rents despite repeated efforts to diversify its one-dimensional economic model. Riyadh shaved over 400,000 b/d off the country’s production last month in a bid to jolt some life back into prices, according to the latest Platts OPEC production survey.

However, OPEC’s discipline and success still depends on the continued co-operation of Russia.

The Kremlin has cautioned against the alliance – which controls 40% of the world’s supplies – from making any hasty decisions in response to crude’s rout. However, after years of falling back on their foreign currency reserves to support their economies, few producers in the Gulf region have much financial room to maneuver.

Complicating their task further are US producers whose success has undermined the cartel’s power in oil markets. US crude production is forecast to bust through 12 million b/d in 2019 despite lower prices forcing some operators to cut capital expenditure budgets and rig counts beginning to ease.

The number of active permits to drill – which indicates the strength of future activity – end the year at their highest level since 2013. The big question is how long can US output continue to grow and remain economic for operators? OPEC’s tried to answer the question in 2014 when, led by Riyadh, it launched a poorly executed price war to slow down its booming North American rivals. But the tactic failed spectacularly.

Andy Critchlow talked to CNBC about oil market trends in late December

Nevertheless, some analysts have started to question the resilience of US producers – many laden with debt and facing rising operating costs – to continue competing and growing at current price levels.

“If prices remain at these levels for a sustained period, North American producers are likely to begin curbing investment and production growth. That said, the Saudis, the backbone of OPEC+, are already leading by example and have already scaled back their exports this month. We expect improving oil inventory dynamics – primarily in the US – to support oil prices over the coming months,” wrote Giovanni Staunovo, oil analyst at investment bank UBS.

Disruptions to supply are more likely to come from more exotic locations. Venezuela’s oil industry is on its knees and the country’s oil minister Manuel Quevedo – a former brigadier general – will take over OPEC's rotating presidency in 2019.

The South American producer pumped 1.17 million b/d in December, according to the latest Platts OPEC production survey, down 630,000 b/d year-on-year. Elsewhere, the political situation in Libya remains combustible with the threats to its oil infrastructure from rogue militias a regular ongoing occurrence. Of course less oil from either Venezuela and Libya flowing onto markets could be a short-term blessing for prices but it also could be a sign more frightening volatility is ahead.

This article was previously published as a column in The Telegraph