Wednesday, 27 October 2021 01:25 GMT

Geopolitics key risk to watch for oil markets


(MENAFN- Khaleej Times) The summer months brought some turbulence to the oil market. The steady surge witnessed earlier this year came to a halt and instead oil prices moved down and up within a $65 to $75 range.

This raises the question if the latest prices swings are a sign to watch more closely, a sign that the market is changing direction.

The oil market mostly follows textbook economics, like any other commodity market , once we cancel out the omnipresent noise. Tightening fundamentals as mirrored in declining storage levels bring tailwinds to prices and vice versa. Thanks to the sizeable futures trading, oil takes part in financial markets and gets exposure to the flip-flopping of the economic mood.

The bullishness or bearishness adds a short-term sentiment-related cyclical element on top of the more medium-term economic-related cyclical element. Separating these overlapping cycles is one of the everyday challenges for analysts.

The strong rebound in world oil demand seems to be over. Growth rates should slow as economic activities are largely back at pre-pandemic levels. Of course, there are various niches seeing a longer lasting road to recovery, as there are the occasional pandemic hiccups that add a level of uncertainty.

Especially countries committed to a zero tolerance strategy against the pandemic will likely continue curbing the economy partially and regionally. Yet the strong rebound in leisure activity in Europe and North America this summer, the pronounced driving and busy highways, added some extra barrels to oil demand.

Looking ahead, we see global economic growth moving past its peak and we see global oil demand growing at a slower pace going forward. What matters for fundamentals and prices is the gap between supply and demand. This gap defines if storage levels decrease or expand, if markets tighten or loosen.

The petro-nations and the shale business incrementally add output, the former as part of the agreed easing of the supply curbs, the latter as today's elevated prices offer a cash gusher.

Drilling activity resumes at a slower pace than in previous episodes but at high enough levels to offset natural decline and grow output. Even though most listed shale companies focus on profits rather than growth and show financial prudence, there are enough private players eager to exploit the opportunity.

Supply growth should exceed demand growth, slowing and eventually reversing the fundamental tightening. We remain confident that from this perspective oil's cycle looks mature. We still see oil prices in 2022 rather below, in the 60s, than above today's levels.

The wild card for oil seem to originate rather from the supply than the demand side of the market. The petro-nations under the lead of Saudi Arabia and Russia showed surprising discipline with easing the supply curbs. However, one of this summer's gatherings unwillingly became a reminder of the inherent fault lines within the group.

The disagreement circles around each country's output capacity, recent investments and its adequate reflection in quotas. The simmering conflict in part, are a messenger of things to come: the concern that oil demand peaks sooner than envisioned as the world rapidly adopts electric cars, and the fear that the petro-wealth cannot be monetised in time. Indeed, the share of plug-in cars sold in Europe and China climbed to around 20 per cent, topping even the most optimistic predictions.

The electrification momentum should not be underestimated. The supply balance and petro-nation cohesion looks fragile, and Iran and its confrontation with the West on nuclear issues seems to be an element that could break things. Although Iran's return of oil exports seems somewhat postponed compared to earlier expectations, it would be wrong to assume that these barrels will not return at a later stage and at volumes that matter.

Supplies are politically tight not structurally. Oil politics is a function of oil prices, rather than the other way round. Geopolitics and not the pandemic is the key risk to watch for oil markets heading into 2022.

The writer is head of economics and next generation research, Bank Julius Baer. Views expressed are his own and do not reflect the publication's policy.

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