Oil makes up about 2.5 percent of the global GDP, and supplies a third of humanity’s primary energy needs. While renewable sources of energy – such as wind and solar – are picking up steam, they have so far been unable to make any significant dent in the global economy’s dependence on oil. Economic literature suggests that oil is both a cause and an effect of economic growth: energy, as a factor of production causes economic growth, and as a consumption good, increases with increases in incomes. Oil is, therefore, the lifeblood of the world economy – and once again, its price is on the rise.
About two weeks ago, members of the Organization of Petroleum Exporting Countries (OPEC) met with Russian officials in Algeria to decide whether oil production should be propped up to curtail the upward pressure on price. The meeting ended with no formal recommendation for any additional supply boost. “The reason Saudi Arabia did not increase more is because all of our customers are receiving all of the barrels they want,” remarked Saudi Energy Minister Khalid Al-Falih, whose country is the largest oil producer among OPEC members. When markets opened the following Monday, the price of a barrel of Brent crude (the global crude benchmark) jumped more than 3 percent to reach $81 per barrel. And this week, it rose to a four-year high of $81.20.
The meeting in Algeria came following a Twitter tirade from US President Donald Trump, who has been accusing OPEC of restricting supply in order to artificially raise prices. As the US goes into midterm elections this year, President Trump has been rallying for lower gasoline prices to gain support of potential voters. However, some of his policies are responsible for the price increase, and are ironically hurting his own cause: first, by directly causing supply shortages, and second, by indirectly causing instability (and speculation) in oil markets.
Talks of a “NOPEC” bill from US lawmakers is gaining steam
The strongest blow to oil supply came from the US president himself, when he announced in May this year that he was going to withdraw the US from the Iran nuclear agreement that the Obama administration (and five other countries) had negotiated in 2015. As part of the withdrawal, he announced, economic sanctions on Iran would be re-imposed. To put things in perspective, Iran produces about 4 million barrels of crude per day, and was the 5th largest exporter of crude in 2017, and the third among OPEC members.
Some of these sanctions were restored last month in August, while others will take effect in November. Sanctions that took effect in August include, among other things, a blanket ban on the Islamic Republic from buying or acquiring US dollars, which has already begun to hamper the country’s ability to trade internationally. Sanctions to be implemented in November primarily target the country’s shipping ports and its energy sector, by promising action against parties that do business with Iranian companies.
Iran’s oil producers have already begun to feel the sting of these sanctions. Big buyers of Iranian crude, such as China and India, are curtailing their purchases in anticipation of additional sanctions in November. As a result, Iranian crude production has dropped by 20 percent and exports by a whopping 62 percent since the Trump’s announcement in May. Additionally, the US State Department has conveyed a message to European diplomats in recent talks, stating that companies buying Iranian crude oil must completely cut those deals by the start of November. If the US is successful, 1.4 million barrels per day of Iranian crude could be wiped off of global markets.
In times of such volatility in oil markets, President Trump’s attempt to strong-arm OPEC to increase production has not helped the situation. Amid pressure from the president, talks of a “NOPEC” bill (No Oil Producing and Exporting Cartels) from US lawmakers is gaining steam. Congress had discussed various forms of NOPEC legislation since 2000, but both George W. Bush and Barack Obama had threatened their veto power to halt it from becoming a law. However, given his past record of opposition to OPEC, many believe that President Trump may break this precedent. The legislation would tweak US antitrust law to explicitly ban collusive behaviour that OPEC engages in, and make illegal any activity to restrain the production of oil to support prices.
The situation in South America does not help either. OPEC’s 6th largest oil producer – Venezuela – a country that also supplies about 10 percent of US oil imports, is going through its own crisis. The country’s economy is in free fall as hyperinflation and food shortages are driving millions of Venezuelans out of the country. The country has been losing about 50,000 barrels per day in oil production every month since the start of 2018, and currently, production is at its lowest point in nearly seven decades. This has caused an unprecedented exodus of workers and field shut downs, which means that the country could lose a serious chunk of its production before the end of 2018.
Since the OPEC meeting in Algeria on Sunday, chatter regarding the possibility of oil rising to $100 is making the rounds. In case oil does reach the $100 per barrel mark, it may not be able to sustain price at this level in the longer-term, since demand may be threatened by the US-China trade war and production may be increased by US drillers. Uncertainty, however, is once again on the rise, and the likelihood of an oil spike and crash scenario (similar to the one observed during the 2008 crisis) has increased according to commodity analysts. As far as predictions go, Bank of America expects an oil price of about $80 a barrel for the next year, while Citigroup Inc. sees risks that it could go well beyond $80 before 2018 ends.
One thing is for sure: the plethora of uncertainties gathering around oil markets are here to stay, and will extend beyond the end of 2018. Other than supply-side shortages, turmoil in emerging economies could amplify risks in oil markets, and could also hurt global demand growth. Sanctions imposed and trade wars initiated by the US could further add to market volatility. And if all else fails, one can always count on President Trump’s tweets to cause global markets to gyrate in panic.