Point of balance: what will happen to oil prices?

The optimism against the backdrop of war

The failure of the talks in Doha a week ago promised gloomy prospects for oil prices. During the last months of the process the largest oil producers created the background information that contributed to the price increase. Although the agreement on “freezing” of production at the levels of January 2016 could not directly affect the current balance in the global oil market, it could become a Testament to the possibilities of cooperation of producer countries to influence the world market.

However, Doha has failed. The parties have failed to agree on the previously announced “freezing”, but even to agree on a common statement. In this sense, the failure was similar to the December OPEC meeting — then the final negotiations were also greatly delayed, to reach agreement failed, and the final press-conference has produced a painful impression. After the December meeting of OPEC began a new round of reduction in oil prices during which prices fell by more than 50%. Doha once again demonstrated that non-oil interests of the participants too contradict each other. Saudi Arabia, which supported the earlier “freezing” the production was not ready to join the agreements that create any benefit for Iran. Politics was more important than the economy.

The vast majority of analysts and experts assumed that the failure of Doha is a strong bearish signal for the market, as it increases the likelihood of maintaining price war between manufacturers and growth of market imbalance. Indeed at the opening of trading on Monday, 18 April, oil prices declined by 6-8% “in Doha”. However, over the following days, oil prices more than compensated for the failure of this last week Brent quotes rose by 5%, WTI — by almost 9%. News about the completion of strike of workers of oil industry in Kuwait had no impact on the prevailing, market optimism.

What’s going on?

Why the failure in Doha, in contrast to the December meeting of the OPEC, have led to the opposite result in terms of the reaction of oil prices. Here two variants are possible.

First. The increase in oil prices in the last two months was not associated with the rhetoric of “freezing”, but simply coincided with it in time. There are several factors which have also contributed to rising prices. The mood of panic in financial markets that prevailed in January-February, changed to the opposite — the over-optimistic. This was facilitated by measures to further easing of monetary policy in developed countries (negative rates in the Eurozone and Japan), as well as the beginning of another round of stimulus in China. Coordinated action of the monetary authorities were able to stop the panic. The flow of economic statistics the last time though and does not give grounds for optimism, indicates that what is scaring all the recession in the us economy in early 2016 not started. In the United States remains strong, demand for gasoline, the steady decrease in the number of active drilling rigs (leading indicator of future production). This gives reason to assume that the need of the American economy on foreign oil will increase and this will reduce the surplus on the world market.

The second option. The factor of Doha’s impact on oil prices after will be clear of the strategy of Saudi Arabia and Iran in the oil market. The main risk of the failure of the talks lies in the fact that the market will start another round of a price war between the major manufacturers. Saudi Arabia has the capacity to increase production from the current levels by a further 0.5-1.0 million barrels per day. Kingdom by June, plans to complete by June, the expansion of capacities at the field and beginning to supply on the spot market. Freed from most of the imposed sanctions, Iran has demonstrated that it is capable enough to quickly restore the “lost” production.

Currently, it is also possible to observe quite a large amount of unplanned production cuts — accidents in Nigeria, Iraq, Kuwait simple. According to Bloomberg, the volume of unplanned interruptions in production on the world market is around 2.5 million barrels per day. However, it is likely that these disruptions are temporary and in the coming months, can be renewed. If all these producers will increase production and will start price competition for spot buyers on the physical market — this will inevitably affect the prices.

What’s next?

The situation is the spring of 2016 dangerously like last year. In the first half also saw a significant rise in oil prices, which by may 2015 exceeds $65/barrel and it seemed that the worst is behind us. However, concerns about the sustainability of the Chinese economy, the trigger for which was the devaluation of the yuan, led to the failure of prices in August 2015, and then in January 2016. Production in the United States was much more resilient to lower prices than it was predicted by us authorities themselves in the face of the energy information Administration (EIA). OPEC has again shown the inability to influence the market and increase the production. The result of all that steel prices below $30 a barrel — the lowest in the last 15 years value

To predict oil prices — difficult to systematically sure — impossible. However, it appears that the proverbial “bottom” in the market has already passed. Will require a new combination of several strong negative shocks to “restore” prices below $30/barrel. And in conditions of seasonal growth in the 2-3 quarters it becomes more complex.

However, the fundamental factors that would justify the possibility of further significant growth in prices is also not visible. Risks of a price war between the major producers remain high. Stocks of oil in storage is still increasing, albeit at a slower pace. The ability of Central banks indefinitely to counter structural economic changes, such as the slowdown of China’s economy, also raises questions.

The most likely scenario seems “flat” market in the next few months. During this time clearer, what are the strategies of Saudi Arabia and Iran in the market of physical oil. It will become clear whether whether justified expectations of strong production cuts in the United States. After the market you will find the answers to these questions, will be followed by another strong movement to one side.

The authors ‘ point of view, articles which are published in the section “Opinions” may not coincide with ideas of editorial.