November 15, 2018
The price of crude oil fell 7 percent last weekend, dropping below $55 per barrel after falling for 12 consecutive days. This period marked oil's steepest decline in more than three years and, while prices have since rebounded, the sentiment is still bearish.
What's most alarming is the rapid shift in the oil outlook. Just a month ago, we marked the highest price for crude in four years, and much of the world was fretting about prices hitting $100 per barrel. Now, a sharp turnaround has occurred and markets are looking at a $50 per barrel target.
Why the sudden change, and what impact does it have on the global financial markets?
From the supply side, top oil producers such as Russia and Saudi Arabia ramped up supply after the Iranian sanctions. The U.S. also increased fracking supply around the same time. But the Iranian sanctions did not turn out to be as restrictive as they initially seemed: The U.S. granted waivers that allowed eight countries to continue to import Iranian oil, which eased concerns about supply.
While it looked like the supply side was a moving variable, according to Bloomberg economists the drop in oil prices is largely due to weaker global demand. Rising trade tensions clouding the economic outlook, a higher U.S. dollar and reduced demand from emerging market countries for oil are the primary drivers behind this trend.
But structural changes are also taking place. The profits that result from processing crude oil into vehicle fuel have plunged to their lowest levels in three years. Chinese car sales have been slumping and electric vehicles are gaining in popularity.
In the foreign exchange market, we are seeing a divergence between countries that import oil versus export oil. For instance, oil exporters have seen their currencies drop. The Colombian peso, Norwegian krone, and even the usually stable Saudi riyal have all seen large downward pressures.
Meanwhile, oil importers such as India, Turkey and Brazil have seen their currencies strengthen to two-month highs, though with further interest rate tightening expected from the U.S. Federal Reserve, this may not be a one-way trend going forward.
Our View: This sudden "crude oil awakening" and shift in the outlook for heavy crude oil is very interesting. While the long-term consequences may not be obvious, this could be the beginning of move toward less reliance on the supply of oil produced by OPEC. In the short-term, reduced global demand and volatile stock prices may reduce pressure on the Fed's future tightening path. It will be interesting to see if we're at the start of a shift in the geopolitical landscape.
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