Strategy & economics

Chart of the month - November

Our Global Economist looks at how oil prices have hit a two year high amid heightened geopolitical risks and supply adjustments

10/11/2017

Janet Mui

Janet Mui

Global Economist

Brent crude oil prices


Source: Bloomberg

Brent crude oil prices hit a two year high of US$64 per barrel, after gaining over 13% since the beginning of October and breaching the 1 year trading range of U$S40-60 per barrel. The higher crude oil prices over the past month reflect an increased geopolitical risk premium, declining global oil inventories, and higher expectations for global economic and oil demand growth.

Geopolitical risks have heighted in the Gulf region, with increased domestic and international risks for Saudi Arabia, the world’s largest oil exporter. One major development was the move by Saudi Arabia's Crown Prince to tighten his grip on power as a number of princes, government ministers and billionaires were arrested in an anti-corruption probe. This poses domestic political tension and business uncertainty that may disrupt the Kingdom’s oil policy. At the same time, there has been an escalation in tensions between Saudi Arabia and Iran, with Saudi Arabia accusing Iran of direct military aggression after intercepting an Iranian supplied missile. In addition, renewed threats from militants in Nigeria, sovereign debt concerns in Venezuela and the independence referendum in the Kurdistan Region of Iraq, all pose disruption risks to oil production.

There are signs that supply side adjustments are taking place after the production cut agreement by the Organisation of Petroleum Exporting Countries (OPEC) last year. The US Energy Information Administration (EIA) estimates that global oil inventories fell by half a million barrels per day in the third quarter of 2017. This was the third consecutive quarterly decline, with falling production from the OPEC being a major contributor. It seems likely that the current OPEC agreement will be extended to the end of 2018 at the November meeting, with Saudi Arabia, Iraq and Kuwait all confirming that the group had achieved broad consensus. Interestingly, despite recent oil price strength, US shale producers have not ramped up drilling activity, as oil rig counts have instead fallen over the past three months to the lowest level since May 2017.

On the demand side, global economic activity remained robust with accelerating growth in both developed and emerging markets, leading to higher expectation of oil demand. As the global oil market is expected to remain in tight balance until at least the end of 2018, heightened geopolitical risks and any unexpected disruption to supply can potentially put upside pressure on oil prices in the short-term.

The key question is whether higher oil prices are sustainable. According to the latest OPEC World Oil Outlook, shale oil production is expected to grow to 7.5 million barrels a day by 2021, which is 56% higher than forecast a year ago. In the past, shale oil production has shown resilience and ability to bounce back quickly when oil prices rise, so higher production may be just around the corner. In the longer-term, the rising production of electric cars as well as car sharing activity can be disruptive to the structural demand in oil. Overall, despite the recent strong momentum, oil prices remain structurally challenged and may struggle to sustain at higher levels.

Author

Janet Mui

Janet Mui

Global Economist

Janet is an Economist working in the Investment Strategy Team and a CFA charterholder. She joined in 2011 and previously worked in Citi Hong Kong as an analyst in Global Portfolio Management and subsequently as a relationship manager to multi-national clients. Janet graduated with a BSc in Economics from the London School of Economics (first class honours), holds an MBA in Finance from the University of Cambridge and obtained a Postgraduate Certificate in Econometrics from Birkbeck College, University of London.

This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 12 Moorgate, London, EC2R 6DA. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. 

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