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Speculation spurs oil to $80 per barrel
May 19, 2018, 5:02 pm

For the first time since November 2014, oil crossed US$80 a barrel last week fueled by fears that revived sanctions on Iran by the US could reduce crude exports from OPEC’s third-largest producer. In addition, the decline in recent months of crude exports by Venezuela has further roiled an already taut global oil market.

Global inventories of crude oil and refined products have also dropped sharply in recent months due to robust demand and sustained OPEC-led oil production cuts. Oil stocks are expected to drop further as the peak summer driving season nears, offsetting increases in US shale output.

On Wednesday, French oil giant Total warned that it might abandon a multibillion-dollar gas project in Iran if it could not secure a waiver from US sanctions. The CEO of Total said that he would not be surprised to see oil touch $100 in the coming months. And, almost on cue, British-Dutch oil and gas multinational Shell announced that it was halting crude exports from a major Nigerian pipeline.

Despite the timed press releases that boosted oil prices, the latest United Nations World Economic Situation and Prospects (WESP) report shows that, as of mid-2018, growth in the world economy is surpassing expectations and global GDP is now expected to expand by more than 3 percent this year and in 2019.

In the past, higher oil prices have negatively impacted global growth; so will it be any different this time?

As the economist Anatole Kaletsky observed, “Financial markets have a disconcerting habit: predictions viewed by investors as completely obvious often turn out to be wrong.” The outlook for oil prices could turn out to be such a case, for several reasons.

For one, the real reason behind higher prices could be attributed more to speculation than to any real global demand. To ‘buy on the rumor and sell on the news’ is a time-honored principle of financial speculation. Unprecedented recent purchases of oil contracts by non-commercial speculators in the New York and London futures markets implies that the jump to $80 per barrel came less from global demand and more from speculators. Moreover, oil for future delivery in 2020 still costs well below $70, creating what is called a ‘deep backwardation’ that often portents a step price decline. This financial condition was last seen in the autumn of 2014, just before the most recent price crash.

Moreover, the revived sanctions on Iran by the US could turn out to be an empty gesture, with little or no support from other signatories to the 2015 Iran nuclear deal, namely the United Kingdom, Russia, France, and China — plus Germany and the European Union.

Already, the EU has begun reviving legislation that will allow European companies to continue doing business with Iran. An updated version of the EU’s ‘Blocking statute’, which was introduced in 1996 to circumvent US sanctions on Cuba, could be put in place before 6 August when the first sanctions are set to take effect. The statute will prohibit European companies from having to comply with the penalties and permit compensation for affected firms.

Even when one looks at the fundamentals of oil production, it is far from clear that sanctions will reduce Iran’s exports sufficiently to affect the global balance of supply and demand. Most of the 2.5 million barrels of oil that Iran currently produces is sold to China, India and Turkey, all of which are likely to ignore or circumvent the US sanctions. The only vulnerable segment of Iran’s crude exports are the 750,000 barrels per day that it supplies to the European Union, the South Korea and Japan. Even here, this surplus would doubtless be diverted to countries such as India and China.

The fact that oil traders constantly redirect oil cargoes around the globe explains why most analysts expect sanctions to reduce global oil supplies by less than 500,000 barrels a day. A shift on this scale would be smaller than the 700,000-barrel collapse of Venezuelan oil exports since last year and much smaller than the increase in US daily output of 1.1 million barrels projected over the next 12 months, not to mention the probable reduction in global oil demand caused by the sharp increase in prices since last summer.

Higher oil prices eventually lead to a slow-down in economic growth and leveling of demand in the developing world, while in the industrial world demand could decline due to increasing replacement of oil by natural gas or renewable energy, as well as the widespread adoption of electric vehicles. In short, the global balance of oil supply and demand will depend more on the performance of the world economy and the behavior of other oil producers, than on sanctions to Iranian crude exports.

Another reason why the US-Iran confrontation could lead to lower, not higher, prices is the political fallout from higher prices for the Trump administration. If oil prices rise much further during the summer ‘driving season’ that soon starts in the US, Trump will be blamed by voters and Republicans could suffer in November’s midterm congressional elections, especially in Midwestern swing states.

Past experience suggests that US political interests usually prevail, at least in the short term. That was certainly true after the two Iraq wars when oil plunged by 45 percent in 1991, and by 35 percent in 2003, within a month of the US launching its attacks. Though a fall on this scale seems inconceivable today, oil prices are likely to head down than breach the $100 mark.




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