PETROANALYSIS || ARTICLE
2018: Geopolitics and China-US trade war push up oil price
This note will evaluate the evolution of the main data of the oil market in 2018: prices, market fundamentals (supply and demand) and financial market operations.
Oil prices rose of 31% in 2018 with respect to 2017. This was despite the strengthening shown by the US dollar (4%) which made the value of black gold even more expensive. The value of oil accumulated an increase of 63% on average since 2016.
The upward trend occurred despite the significant downward correction experienced by the main crude oil markers between November and December of 2018. In this regard, the West Texas Intermediate (WTI) crude oil fell 31% between the end of October and the last day of December 2018.
The rise in prices occurred in a context of greater global trade tensions, intensification of the geopolitical problems associated with the oil market and a high volume of operations in the oil financial markets. Thus, the strengthening of supply and weak demand for crude oil was not enough to weaken oil prices in 2018.
Greater global trade tensions in 2018.
In March 2018, the President of the United States, Donald Trump, applied tariffs on imports from China, due to unfair commercial practices and the disrespect of intellectual property rights. China responded immediately by imposing tariffs on imports from the US, which started this trade war.
The US imposed three rounds of tariffs on Chinese products for USD 250 billion of the value of the goods in 2018. Simultaneously, the Chinese Government took similar measures in retaliation.
Washington escalated the trade dispute by imposing new tariffs in September 2018 that affected Chinese goods valued at USD 200 billion. These taxes started with a 10% rate that would rise to 25% until the beginning of 2019, unless the nations reach an agreement.
According to the International Monetary Fund, the aforementioned trade war could reduce growth forecasts between 0.5% and 1% of GDP in 2019 and until 2020.
Intensification of the geopolitical problems.
The United States imposed all sanctions that had been lifted as part of the Iranian nuclear deal. The US penalties covered shipping, shipbuilding, finance and energy. In this sense, more than 700 individuals, entities, vessels and aircraft were put on the sanctions list, including major banks, oil exporters and shipping companies. The US Treasury also said that the Brussels-based Swift network for making international payments was expected to cut off links with targeted Iranian institutions. Being disconnected from Swift would almost completely isolate Iran from the international financial system.
The deterioration of geopolitical tensions between the US and Iran increased the risk premium associated with the greater probability of interruption of the supply from this important oil country and raised the price of oil.
The strengthening of crude supply and the demand slowdown in 2018.
The increase in oil prices occurred despite the greater supply of crude in 2018. In this regard, the total supply went up and was above 100 million barrels per day on average in this year. This represented a positive variation of 2.4% y/y in 2018, higher than the variation observed in 2017 (0.7% y/y) with respect to 2016.
This greater supply was produced, largely by the higher pumping of non-OPEC countries (4% y/y), led by the United States (14% y/y). In the OPEC countries, Saudi Arabia increased its production by 4.0% y/y.
In contrast, the demand for crude oil showed a lower growth rate in 2018 (1.5% y/ y) with respect to the previous year (1.7% y/y). In this sense, purchases from Europe stagnated and those from China expanded (3.8% y/y) to a lesser extent compared to 2017 (4.4% y/y). Thus, the combination of a greater supply and a weakening of demand led to a surplus of crude oil, which reached around 400 thousand barrels per day in 2018.
When evaluating the behavior of the fundamentals of the oil market, associated with the evolution of demand and supply, it becomes difficult to explain the upward trend of oil. In this regard, we will have to evaluate others factors to get answers.
Increase in long positions in financial markets.
Another element that we cannot rule out when evaluating the rise in prices in 2018 is the increase in purchases of long positions in the financial markets. In that sense, there was an increase in purchases of long positions contracts, associated with rising price bets in 2017 and at the beginning of 2018. Although this phenomenon was observed with greater intensity in 2017 (24.7%), until May 2018, the purchases of long positions were 24% above the average value in 2017.
In this regard, the volume of purchases of long positions in the oil financial markets reached historical maximum levels in the series in January and then in April 2018. This trend changed in the last months of the year when there was a fall in the demand for long positions and a rebound of short positions (20%).
Meanwhile, the pronounced fall in prices that was observed in the last two months of the year (30% on average), was due, among other factors, to the increase in the supply of crude oil, particularly from the United States, and the lower production from the Organization of Petroleum Exporting Countries (OPEC).
In this sense, the aforementioned increase in pumping led to a surplus in the market in 2018, which had manifested itself with greater intensity in the second half of the current year. This can be explained by the greater extractive effort of non-OPEC countries (4%) in 2018, led by the shale phenomenon in the United States (14%) and to a lesser extent in Russia (1.8%).
The above described contrasted with the drop in the pumping of the OPEC (-0.2%) in response to the brutal collapse of Venezuela and despite the higher sales of Saudi Arabia (3.5%). Thus, the South American country stopped producing about 600 thousand barrels per day in 2018, according to secondary sources of OPEC, which was equivalent to a fall of 35%.
In summary, the evolution of the fundamentals of the oil market associated with the increase in supply and the weakness of demand cannot explain convincingly higher crude prices observed in 2018.
In contrast, the greater geopolitical tensions associated with the re-imposition of sanctions on Iran and the increase of long positions and the consequent collapse of short positions in the oil financial markets give a better answer to the causes that explained the behavior of the prices that year.
On the other hand, we cannot rule out the impact that the commercial war between China and the United States could have within the oil market. This event raised the global uncertainty and negatively affected the price of goods, services and the commodity markets.