Written by Jameel Ahmad, Global Head of Currency Strategy and Market Research at FXTM
The news that both Libya and Iraq are facing supply disruption challenges to their production of Oil has alarm bells ringing and investors excited at the opening to the new trading week over the prospect of a stronger valuation for the commodity. Both Brent Crude and WTI valuations each advanced to their strongest in over a week at $65 and $59 respectively, but I am doubtful over whether the current situation is enough to provide a sustained move higher in Oil.
What the initial bump in Oil prices has shown once again goes is how sensitively investors can react to geopolitical themes in the Middle East region, although the current situation (where armed forces have shut down a pipeline in Libya) can put a limit in place for how much confidence investors can have that now is the time to expect a meaningful move higher for the commodity.
It was only two weeks ago that there was euphoria in the air over the increased threat that US-Iran issues might have extended into a conflict after all, leading to the price of WTI alone extending by over $5 during the opening trading day of 2020. But this momentum didn’t last and I struggle to find confidence that the situation in Libya and Iraq will change Oil prices fortunes, given that not even US-Iran threats achieved this. The market today is so much better-supplied than 2012, where the cutting off of Libya’s oil exports helped push WTI to $120 a-barrel. The advances in Oil price to the news of Iraq/Libya production issues to begin the week has been only $1 in comparison to those days.
Only today (January 20) the IMF trimmed the global economic outlook once again, providing investors with another nudge that the key risk for Oil prices to consider is there not being enough demand for supply of the commodity – not that there is a risk of not enough supply to meet demand. If anything, a consistent withdrawal of supply from the market is what is required to boost Oil valuations with a shot of strength in the arm.
The next OPEC meeting is not until March 5 and 6, suggesting that geopolitical themes and global economic sentiment will continue to pull the strings for market valuations until the end of February. Even if as much as 1million, or more barrels per day of production is lost due to the Iraq/Libya issues there are many other producers who could step up and fill in the gap. This includes OPEC members like the UAE and Saudi Arabia, or even those not involved in OPEC at all such as the United States.
It is often not fully understood that the United States now stands as one of the largest producers of the commodity in the world and it can step in to provide supply to the market, if necessary. Since 2009 – 2018, the total share of OPEC global crude production has ranged from 41.7% to 44.6% and the group is no longer the dominant force in Oil than it was in the past. In contrast, the United States has transformed itself as a net exporter of Oil in less than a decade, an unprecedented achievement and the IEA even thinks that the United States will account for 70% of the total increase in global capacity until 2024.
I actually expect for the next OPEC meeting to show what pressure the group are under to extend production cuts even further into the new decade. Unless there is a situation where transport links throughout the whole of the region are cut off, investors can only react so much to geopolitical noise and will instead focus on global themes. The tensions to begin the year between the US-Iran have calmed down substantially since the escalation (fortunately) and this prevents the probability of a sustained advance in Oil prices.
With the overall dynamics surrounding Oil price evolving so greatly from where it was previously, there are other asset classes to consider when geopolitical risks spread into the region when monitoring how investors are reacting. The Japanese Yen remains at its weakest level against the US Dollar since May 2019, suggesting that international investors are approaching the Yen as a safe haven to regional risks, while the price of Gold has budged only $6 to the developments.
Even Aramco saw its share price advance by 0.73% on Monday 20 January and one of the holistic advantages that the IPO has bought to investors is that the share price of the company can now be monitored against geopolitical risks in the region, similarly to how investors look at Oil price when there is an escalation in regional risks. Unless there is a real disruption to transport links throughout the GCC and ME, I do not think that the situation in Iraq or Libya will at this stage have a material impact on Aramco either.
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