Complex Made Simple

GCC diplomatic crisis trims oil price

Crude oil traders are tip-toeing on eggshells after the Qatar crisis caused a rift in GCC relations. OPEC is the first to feel the fallout, as it’s currently under pressure to maintain the oil supply-cut deal.

The Brent Oil benchmark hit a six-month trough at just under $47.4 in the immediate aftermath of the diplomatic and political storm.

The confrontation and political posturing appear to be set to continue in the short-term. A tough combination of pressures from reduced oil revenues and tensions over terrorism are taking their toll on the region.

The crisis has overshadowed another piece of news that had heartened the oil bulls.

US President Donald Trump’s latest decision to pull out of the Paris climate treaty is part of his policy of supporting domestic big oil. The bulls were soon slapped down in other market developments. US production continues to rise, adding to over-supply concerns.

As of the week ending June 9, the US added 11 more oil rigs, making a total of 927 rigs currently in action. That makes 21 weeks of continuous growth, according to Baker Hughes data.

In short, every oil trader in the world is frantically pricing in the new odds. An extended rift within OPEC dims the prospects of a resilient extension to the supply cuts. Combined with the US flooding the markets, supplies still outstrip demand. The downward trend shows that the bears are outweighing the bulls.

After the sudden 10 per cent slump last week, it’s clear there are still many weaknesses ahead for the oil price. Much depends on whether the GCC region can mend its differences.

On the upside, the crisis could wane through the summer months. If this happens and relations return to normal, OPEC’s chances of extending the supply cuts into 2018 would improve. There would likely be more support for the oil price.

On the downside, relations could continue deteriorating, wearing on OPEC’s deal and pressuring oil. If the situation escalates at a military level, matters could change dramatically. The risks would increase for oil-producing countries in the GCC, potentially forcibly restricting supply. Demand would rise in this scenario, so the price would be checked only by a continuing boost in supplies from the US producers.

There’s a big gap between the price that satisfies OPEC and the price that US producers can live with; $50-$60 for OPEC; $30-$40 for US Shale. The main reason is economic differences in each region. The differences centre around efficiencies and resilience to market shocks.

The GCC is going through a period of economic transformation, moving towards market efficiencies. There’s a risk that the process could be slowed by the current difficult political climate. There’s no need to point out the problems associated with this possibility.

Long-term, the GCC knows it must follow the course of economic transformation or stay vulnerable to shocks in the oil markets.

Oil market fundamentals haven’t changed significantly since the beginning of the year. The glut was controlled to a degree by OPEC’s supply cut deal, but traders have always been wary of differences within the cartel.

Looking ahead to the third quarter, I expect downward pressure to feed into price resistance. The $50 mark remains a target but there appear to be short-term hurdles in the way.

(The views expressed are author’s own and do not necessarily reflect AMEinfo’s editorial policy)