Oil price rallying, but for how long?
Last month’s agreement for major suppliers to freeze levels of oil output has given the price of crude a boost but the rally is unlikely to be sustained because the state of the global economy cannot easily be reconciled with higher energy prices.
A global mismatch between supply and demand remains, geopolitical differences between some major oil producers are unresolved and, arguably, the world may not actually be able to afford much more for a barrel.
The agreement itself, signed in Doha on February 16, saw Saudi Arabia, Russia, Venezuela and Qatar provisionally freeze crude oil production at January 2016 levels.
Given that January saw both Russia and Saudi Arabia pumping at close to peak production levels, the freeze locks in very high output that had already weighed down the crude price.
It is a bit like being the driver of a car going at full throttle who promises not to go any faster.
Additionally, the Organisation of the Petroleum Exporting Countries (OPEC), in which Saudi Arabia takes a strong lead, seems unlikely to embrace an output cut when it next convenes in June.
Saudi Arabia will have a close eye on the level of oil production in Iran, with whom Riyadh has significant political differences.
The Saudi government will likely not wish to gift Tehran a much higher oil price now that Iran’s nuclear deal with western powers has reopened the door for increased Iranian oil and gas exports.
Equally, Saudi Arabia still finds itself on opposite sides to both Iran and Russia in Syria’s civil war.
But even assuming the freeze in production holds, at an output level seen in January, the International Energy Agency (IEA) had already said on February 9 – and with January’s data at their fingertips – that global oil supply could outstrip global demand by 1.75 million barrels a day during the first half of 2016.
If that in itself is not enough to undermine arguments for a sustained rally in oil price, there is also the harsh reality that trends in global trade and industrial production do not necessarily lend themselves to any material increase in demand for oil at the present time.
“According to preliminary data, in December 2015 the volume of world trade did not change from the preceding month, having declined 0.3 per cent in November,” said the CPB Netherlands Bureau for Economic Policy Analysis (CPB) on February 25.
And if that gives pause for thought “according to preliminary data, world industrial production decreased 0.2 per cent in December, following a 0.3 per cent decline in November,” the CPB noted.
That hardly supports any case for higher aggregate demand for oil.
Data released by Seoul on March 1 merely reinforces the point that exporting nations are struggling in the face of adverse trade winds.
South Korea, the world’s sixth-largest exporter, saw exports tumble for the 14th consecutive month in February, down 12.2 per cent compared to the same month in 2015.
The key driver of the decline was the 12.9 per cent fall in exports to China which is South Korea’s largest market and takes up some 25 per cent of Korea’s total shipments, although it should be said that the timing of the Lunar New Year holiday may have had an impact.
Yet the economic situation in China is itself still somewhat cloudy.
The People’s Bank of China’s February 29 decision to cut banks’ reserve requirement ratio by 50 basis points to 17 per cent might help release new lending to stimulate economic activity, but there is still a likelihood of millions of job losses in China’s state-owned companies in the next few years.
This too undermines arguments that demand for oil will pick up.
The Organisation for Economic Cooperation and Development (OECD) summed up the global picture in comments made just before last month’s G20 gathering in Shanghai.
“Global growth prospects remain clouded in the near term, with emerging-market economies losing steam, world trade slowing down and the recovery in advanced economies being dragged down by persistently weak investment,” the OECD said on February 26.
And this was before German Finance Minister Wolfgang Schaeuble stated in Shanghai that “fiscal as well as monetary policies have reached their limits”.
Even if the world economy could actually afford a higher oil price, which on the balance of the economic evidence seems doubtful, global aggregate demand for crude is not going to increase rapidly enough in the coming months to justify one, even if the agreed supply production freeze holds.
Oil’s price rally may run out of steam.