Oil surges, but will it fall back?

The price of Brent crude oil has risen sharply; if this continues it will be good news for the oil companies. But will it continue?

Article updated: 14 May 2019 1:00pm Author: Michael Baxter

There is a discrepancy. The price of Brent crude oil is at $70.41 a barrel, as I write. It has risen by around 40 per cent since the latest low point, back in December. Brent crude is hovering at a seven-month high. However, the 12 month-high was set last October when it got close to $90.

By contrast, the West Texas Intermediate gauge of the oil price is at $61.

In theory, the price of Brent crude, which is more reflective of market conditions in Europe, and West Texas Intermediate, which is more reflective of conditions in the US price, should converge. There was a time when the two indexes did.

These days, however, the fracking revolution in the US has had a disproportionate effect on the oil price.

The question is, which way next?

There is one set of arguments to suggest up, another set to suggest down and a third set which may tip the balance.

Forces pushing up

It’s not rocket science, it’s not even mechano rocket science. Iran is back to its position of enmity with the US. President Trump described the deal President Obama agreed with Iran as the worst deal in history. For a while it seemed as if the West and Iran were mending their differences, not any longer.

Sometimes, one corrupt regime seems preferable to another corrupt regime when the dollar and strategic interests align. So Iran is relegated to pariah status again. The US had given notice to purchasers of oil from Iran to cease buying from the country by May 1st or face sanctions.

“Sweat not”, said Saudi, “We can make up the short-fall.” Maybe it can, but oil supply from the region is not exactly surging — indeed Saudi cut oil output in April and is not, shall we say, unenthusiastic about oil trading at a price north of $70.

But now things have got complicated. Four commercial ships have been sabotaged off the Straits of Hormuz. Who was responsible? No one knows, but we have our suspicions. ‘I ran’ away, from naming names — excuse the poor grammar, but I think you know the point I am trying to make. Saudi has limited options in transporting oil from the kingdom — and any disruption in the straits could be catastrophic for oil supply in the region.

Throw Venezuela into the story and the supply shock gets more serious — not that this story is new.

Forces pushing down

Fracking has changed the shape of the oil cycle. Because of the innate nature of how it is drilled, production at fracking installations can more easily be turned up or down.

The US frackers have reacted with glee to rising oil prices — output from the seven major shale gas companies is set to reach a record high and is expected to increase by 83,000 barrels a day between May and June.

The big question mark relates to whether shale gas output can increase sufficiently to make-up from any short-fall in the Middle East.

In the long run, it probably can, but I doubt that it could sufficiently make up for any worsening of the situation in the Middle East this year, I don’t think it has sufficient capacity to do that. Not without further investment.

The determining factor

The strength of the global economy will be key. If it slows, as some forecasters predict, then this will push down on the oil price.

On this theme, Capital Economics recently said: “The slowdown in global growth will be more persistent than most forecasters envisage, necessitating widespread monetary policy loosening. While the US may be defying gravity for now, the effects of diminished policy support have yet to be fully felt. And China's fiscal stimulus will not be strong enough to prompt a sustained economic revival.” So, if that is right, the recent rise in Brent crude will probably be short lived.

However, as reported here a few days ago, some forecasters believe the worst of the global economic slowdown is behind us and the second half of this year will see a strong pick-up on the back of new stimulus measures in China, and as one-off shocks hitting the Eurozone economy work their way out of the system.

If that is right, then I see the oil prices heading north of $80, maybe higher.

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.

See what else we have to say