Oil: Will the barrel stop rolling?

by Abheek Barua, Chief Economist, HDFC Bank
Much to everyone’s relief, oil prices eased off during the last week by more than 5% (Brent Oil Futures for December delivery moved below the $80/bbl mark on Friday) from a week’s before four year high of $86.2/bbl, coming on the back of a surprise build-up in U.S. crude inventories (U.S. crude stockpiles rose by 6 million barrels and gasoline inventories jumped 1 million barrels) and verbal assurances by both Russia and Saudi Arabia over the last couple of days on covering up for the lost supply from Iran. Markets have also reacted to reports that the US is considering granting waivers to some countries against sanctions on Iran’s oil exports (though the US has ruled out using the strategic oil reserves), somewhat easing market concerns over tighter crude supply next month.

However, as we write this piece on Tuesday, the 16th of October, prices have moved up again (Futures for Dec delivery edged up 2.4% from Friday’s intra-day low of $79.2/bbl to the current price of $81.1/bbl), which just goes to confirm the fact that the only constant in the oil market is change. This is on the back of the ongoing spat between the US and the Saudi Arabia over the disappearance of a Washington Post columnist Jamal Khashoggi in early October from the Saudi Consulate in Istanbul. As events unfold (the US Secretary of State Mike Pompeo is to meet Saudi King Salman), there are chances that the ongoing controversy may bloom into a bigger risk for the oil markets. Whether the Saudi will use the curbs on oil supply to combat the extreme measures threatened by the US or not? And how much can the US ultimately extend diplomatic pressure on the Saudi – are some of the unknowns. These are likely to define the course of oil prices over the next couple of days. As of now, our reading is that the tensions will likely diffuse in which case oil prices are likely to trade within our targeted range of $78/bbl - $85/bbl. But if the spat escalates, we could see a sharp spike in oil prices even beyond the $85/bbl mark.

On the demand side, recent rout in the equity market across the globe are exacerbating fears about slower global growth and weakening oil demand amid trade tensions. According to the U.S. Census Bureau data, for the first time since 2016, China imported zero barrels of US crude in August. Chinese imports represented 23% of total U.S. crude exports in 2017 and averaged 22% this year--until August.

Prima facie, these developments suggest that the pullback (from $85/bbl levels) in oil prices may be sustained. But many of these factors are either uncertain (whether US will actually grant waivers or not) or temporary. For instance, a build-up in crude inventories in the US could be due to seasonal factors. Refineries are currently in their maintenance mode and hence not taking in as much crude. Our sense is that markets are likely to remain highly speculative until clarity emerges next month (when the Iran sanction come into force on 4th November 2018) on the actual supply/demand balances.