The oil market is in a sweet spot and, so long as demand stays solid, crude prices could see further upside. That said, the sweet spot is maturing, paving the way for a pick-up in volatility going into 2019. Three factors underlie this prospect.
First, while it is too soon to call time on the cyclical world economic upswing, oil is no longer as cheap relative to global growth momentum as it was, say, six months ago. Some demand destruction can be expected gradually to set in. What is more, as inflation expectations respond to rising crude prices, sharp bond yield increases could pose challenges for growth and, therefore, oil consumption.
Second, a smooth transition to the next stage of OPEC+ strategy is by no means guaranteed. With the approach of next month’s review, the different perspectives of the two pillars of OPEC+ – Saudi Arabia and Russia – look set to become more apparent. Riyadh has been signalling since last year that it favours postponing any reversal of the production restraint agreed in November 2016 and has meanwhile found it expedient to over-deliver on its output cuts. The Saudi preference for keeping the oil price higher for longer is unmistakeable.
By contrast, Russia would be comfortable with a price range of US$50-60/bbl; and while taking care to avoid giving any impression of serious disagreement with the Saudis, Moscow would prefer to stick to the global inventories criterion that underlay the 2016 agreement. This would point to a decision to increase output.
Third and finally, by mid-2019 new pipeline infrastructure should be up and running in the Permian, ready to accommodate higher US shale production.
We have long held the view that OPEC+ action was a defensive supply taper in the hope of stronger demand. This hope has materialised, but OPEC’s initiative can no longer be described as defensive. The pendulum is now swinging in the other direction, stoking a price overshoot that will raise the stakes for all parties involved: producers, consumers and investors
WTI prices continued to rise to $74pb in July before range trading. In early October volatility was back in large style. WTI fell from $76bp to $60bp in one month.