What the rise and fall of oil prices says about asset markets
- Hannah Anderson says the dip in prices in October after steady increases all year was due not so much to changes to the fundamentals, but new expectations. Markets move on investors’ risk perceptions, even if they’re not based on reality
Risk assets have faced a good number of difficulties this year, but one of the few assets bucking that trend is oil. Modest global growth kept demand stable, while suppliers continued to exhibit caution around increasing production – many still no doubt wary of creating a glut similar to the one seen in 2015 and 2016 (and the accompanying low prices). As a result, investors pushed oil prices higher in the first 10 months of the year.
Indeed, oil was one of the top performing assets at the end of October. Through to October 31, prices for a barrel of West Texas Intermediate (WTI) Crude (an oil benchmark) rose by 8 per cent, while global equity prices fell by 3.9 per cent.
Global growth, though modest, seemed likely to continue. Supply looked as though it may even tighten on the back of continued discipline by Opec producers. Additionally, the re-imposition of sanctions on Iran, which the US applied on November 5, ostensibly for violations of its 2015 nuclear agreement, created expectations for even lower supply. The conditions seemed in place for a rally in oil prices through to the end of the year.
Anyone who has paid attention to markets recently knows what happened next – oil prices fell for the longest stretch since 1977. Twelve straight sessions (October 29 through to November 13) of price declines erased this year’s gains. WTI’s price drop of 7 per cent on November 13 alone was its eighth largest daily decline since 2010.
Oil prices are extremely volatile and it doesn’t take much to move markets. Yet, all of the conditions supporting higher prices mentioned earlier remain in place. What has changed are expectations.
In its monthly report, Opec forecast mounting excess supply into 2019. For investors already concerned about slowing global growth and its implications for demand, more supply is not what the doctor ordered. Yet, the oil sell-off had been under way for several days by the time this forecast was released. Sentiment had already turned as data showed Saudi Arabia production levels rose this year and Russia seemed hesitant to cut production below the caps agreed to in 2016.
The overall fundamental picture for oil remains reasonably strong. Supply might increase in the future, but producers have been incredibly disciplined in the past couple of years. Saudi Arabia has responded to recent volatility by emphasising that it will do “whatever it takes” to stabilise prices. Given recent history, there’s no reason to believe it won’t take action to keep supply and demand balanced.
It is worth noting that lower oil prices are a boon to consumer-driven economies. Cheaper oil imports could help improve the external positions of several current account deficit countries here in Asia. Any of these countries would certainly welcome the boost, as this year’s combination of an accelerating US economy and stock market, and rising interest rates, have buffeted emerging market currencies and local asset markets.
The factors driving lower oil prices in October and November are likely to fade as supply constraints – either from Opec production discipline or US sanctions on Iran – bite. Demand remains solid and is likely to hold up as global growth continues. Yet, inherently-volatile oil prices respond to more than the supply-demand balance. They are also a real-time reflection of investors’ risk perceptions.
The fundamentals support higher oil prices, but investors will continue to price in their outlook for the year ahead. Most of us have a litany of risks we are watching in the next 12 months – moderating global growth, geopolitical tensions, margin pressures, rising rates and inflation in the US – which probably means it will be a volatile rest of the year for this important global commodity.
Hannah Anderson is a global market strategist at JP Morgan Asset Management