Fundamentals suggest oil price drop is overdone

Thought of the day

by Chief Investment Office 12 Jul 2018

Brent crude suffered its biggest single-day decline in two years on Wednesday, sinking 6.9%. The sell-off was driven by rising US-China trade tensions, the return of disrupted oil supplies from Libya, and a seemingly softer US tone on Iran sanctions.

But in our view the sell-off appears overdone: 

  • The resumption of oil exports through Libyan ports will increase supply, but last month's clashes between militias destroyed some oil infrastructure, which should limit the production recovery. Also, significant production disruptions remain in Alberta, and Venezuelan output continues to decline sharply. Venezuela's crude production dropped below 1.3mbpd in June, its lowest level in 69 years, except for a two-month oil strike in 2002–2003. 
  • The apparent shift in US tone on Iran relates to a partial quote from US Secretary of State Mike Pompeo, who said he would consider waivers to the oil sales ban. A closer examination of the entire quote suggests the existing hard line remains intact. 
  • Market participants ignored price-supportive news. US crude inventories declined 12.6mn barrels last week, their largest drop since September 2016. On Thursday, the IEA said that spare oil capacity could be “stretched to the limit” by OPEC’s decision to raise output. 

So while escalating trade tensions could weigh on oil demand, the global oil market will remain in deficit this year, in our view. Brent prices recovered part of their losses on Thursday and we maintain our Brent forecast for USD 85/bbl over three, six, and 12 months. However, the negative impact of higher oil prices on the world economy is less than in the past. Globally, 7% less oil is needed to produce the same amount of GDP compared with 2007. Net oil producers now represent 34% of global GDP, versus 16% in 2011 and the US is now a net beneficiary of higher oil prices due to rising shale production.

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