Comment: The oil power-play in the Middle East

Both OPEC and non-OPEC countries need to come to a conclusion to freeze crude oil production levels to ensure the oil price does not fall lower, says CEO of Sun Global Investments, Mihir Kapadia.

Mihir Kapadia is the CEO of UK-based Sun Global Investments.
Mihir Kapadia is the CEO of UK-based Sun Global Investments.

As a result of young populations and booming economies stimulating a surge in fuel demand, the Middle East has become the fastest-growing region for oil consumption, bar China, over the last decade. The Middle East is not only one of the world’s most important producers and exporters of oil; in recent years it has become one of the most important and fastest-growing consumers of it, too.

We recently saw volatility in the oil price and it is important to note that if the oil price changes too quickly we will see auto-corrections. Insiders often talk about oil as trading within certain ranges – an increase in crude oil to $50 per barrel or more creates an important psychological shift and is indicative of a more significant move to come.

Bankruptcies in the sector have been bringing down production in the US, seen as one of the key elements to the supply glut being reversed. Recent Baker Hughes data showed an almost 50% decline in rigs in the US in the last year.

Talking about the current volatility of the oil price, it can and should be explained from a ‘supply and demand’ perspective, however that would be simplifying a very complex set of reasons and factors that affect volatility of oil prices.

Politics and currency wars have not just been an influential factor for the volatility of oil prices, but also for other commodities. Rising global economic activity can increase demand and push prices higher, and fluctuations in global growth and oil demand are one possible explanation for the volatility.

Oil prices fell by almost 50% during the 2008 crash, primarily due to a pronounced slowdown in global economic activity, however in recent years the price of oil has decreased for a number of additional reasons. These include the unwillingness of OPEC to reduce supply to an already over-supplied market. The decline of other currencies relative to the US dollar makes oil more expensive for non-US consumers – that reduces the demand for oil, thereby reducing the price.

On the political front, the announcement of a nuclear deal with Iran means oil related sanctions are lifted and therefore another market for oil has opened. Oil prices are, of course, affected by events that have the potential to disrupt the flow but large swings in oil prices often come as a surprise and can be a reflection of changing global economic conditions.

Global oil stocks could begin falling by the end of the second quarter due to the disruptions in Canada and Nigeria. Cheaper petrol is also expected to drive demand. The US government estimates fuel demand for cars will this year surpass a previous record set in 2007. But where exactly the market goes from here is anyone’s guess, so investors should be prepared for any eventuality. The much-anticipated rebalancing of the market may still take a little more time.

Iran’s return to the market has seen an aggressive focus on market share but beyond a certain limit Iran would need Western investment and expertise to increase its oil output. Furthermore, Iran’s oil supplies have entered at a time when the oil market is oversupplied and there are renewed economic concerns, which will dictate a lesser demand in the oil demand growth. Iran has also tried to pre-empt its regional rival, Saudi Arabia, and is beginning to offer more ‘attractive’ prices. However the pricing of Iranian oil will depend on how soon massive cuts in capital expenditure by private companies will affect the output and how rapidly Iran ramps up its sales.

Both OPEC and non-OPEC countries need to come to a conclusion to freeze crude oil production levels to ensure the oil price does not fall lower. On the other hand, if production begins to fall short of demand, oil prices could spike: the exact opposite of what we are experiencing today. The bottom line is that investors need to be prepared for both scenarios.

Looking further afield, the Indian government is looking at spurring industrial growth and its economy is rearing to take off; sustaining this growth in India requires huge amounts of energy, thus crude consumption will go up. The Chinese economy, which has been slowing, will also pick up, again leading to demand for crude, and we will also see the US economy improve.

As global economies are picking up, the major oil companies have started cutting down on new investments; high-cost projects such as deep offshore projects in the pipeline will be slowed down as there is little use in bringing them onstream just to sell in a low market. The net effect of all this will be a fall in production.

However, economies picking up and consumption increasing do not happen overnight. We believe oil prices in the future should hover around the value of $65 as shale producers will become more active at these levels.

Major oil-consuming powers such as China, India, the US and Europe will all continue to influence the price. At the same time, however, the oil wars have not ended and there is sufficient scope for ramping up capacities in Middle Eastern regions. Overall, what will be key to stabilising oil prices will be a steady environment with a lot less volatility.

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