Could Oil Prices Fall To $40?

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By Osama Rizvi –

Crude market volatility has soared in the second half of 2018, with prices touching a four year high before entering their longest losing streak in three decades. Analysts were calling for $100 oil but now seem to think prices will head as low as $40. While inventory build-ups and oil traders continue to impact prices in short term, it is the KSA’s (Kingdom of Saudi Arabia) actions in December, a potential hike in U.S. interest rates and a rumbling trade war between China and the U.S. that will really move the market. Between them, these three factors have the potential to drive oil prices in the $40s.

Saudi Arabia

With fears of a supply glut growing, the oil market is waiting to see if the KSA is going to lead a production cut at the next OPEC meeting. It appears that Saudi Arabia and its allies have gone too far in their attempt to avoid a supply shortage as sanctions on Iran loomed. As prices continue to fall, many in the oil market appear to be waiting on another OPEC agreement – but the outcome of OPEC’s meeting in December is far from certain. Trump appears to be against any production cut from OPEC, enjoying the low oil price environment. Russia, responsible for the largest production cut outside of OPEC, also appears to be against joining in with any production cut. While most in the market are expecting some sort of cut from the KSA and its allies, there remains a chance that the cut will either be less than expected or will simply not happen. Furthermore, the U.S. may at any point alter the waivers it has given to countries importing oil from Iran – upsetting oil markets once again and hurting any potential OP
EC agreement. All of these factors will have to be carefully considered by Saudi Arabia before pulling the trigger on another production cut.

Trade War

There have been very few signs from either Beijing or Washington that the trade war will come to an end any time soon. There is, however, a flicker of hope. Trump and Xi are set to meet at the G20 summit at the end of November, with Trump having planned a dinner after the summit where both leaders will try to find a way to end the trade war. If these two superpowers were able to come to an agreement then oil prices would get a significant boost.
Related: Why The China-Philippines Energy Deal Won’t Last

Most observers, however, are not very hopeful. Michael Spence, a Nobel prize winning economist, does not see a quick fix for the economic tensions between the two countries and thinks the trade war will continue for some time. Chinese fund managers are also doubtful of any success at the meeting. It should be noted here that even if there is an agreement at the G20 summit, it will only produce a “framework” for future negotiations – not a solution or easing of tariffs. It would appear that any oil bulls resting their hopes on the meeting between Trump and Xi are being rather ambitious.
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Interest Rates

The U.S added 250,000 jobs in the month of October, with the overall unemployment rate falling to 3.7 percent. The U.S economy has been showing robust growth of late and wages have also been increasing. All of this forms a strong case for another interest rate hike when the FOMC (Federal Open Market Committee) meets in December. This would result in a stronger U.S dollar which would make commodities more expensive for other countries to buy. This would lead to a fall in oil prices due to relatively low demand.

Each of these three factors will more or less coincide with one another: The OPEC meeting, G20 summit and FOMC. There remains very little certainty over what exactly the KSA/OPEC will agree upon. It seems unlikely that the U.S.-China trade war will be resolved at the G20 summit. The factor that seems most predictable is an interest rate hike and a stronger dollar – both of which will put downward pressure on oil prices.

If the most bearish outcomes were to come to fruition for each of these three events – OPEC refusing to cut production, Trump & Xi failing to agree on a framework and a rising dollar due to an interest rate hike – the prospect of oil prices falling to $40 is not an unimaginable one.

By Osama Rizvi for Oilprice.com

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