Mike Johnson from Portland Analytics Ltd delivers his forecast for oil prices in 2018.
As 2017 begins to draw to a close, now is a prudent time to take stock of the oil markets and start to look ahead at what the next 12 months might hold. The recent bullish run has seen Brent Crude rise to a two-year high, and if the cyclical theory of economics is to hold true, the time may be ripe for a rebound in prices after a sustained period of low prices. So, is the current rise an indicator of what is to come, or simply a flash in the pan?
Rising Interest Rates
The most prominent factor indicating an upswing in prices is the rise of interest rates in both the UK and US. November saw the Bank of England raise interest rates from 0.25 per cent to 0.50 per cent – the first rise since July 2007. However, the US Federal Reserve has raised its rates twice this year alone (amounting to a 0.50 per cent total increase), which could potentially have a significant effect on oil prices.
Why? Well, a substantial increase in US lending figures between 2014 and 2015 indicates US shale oil producers survived plummeting oil prices through sizeable loans – a risk that has seemingly paid off with the Baker Hughes rig count rising consistently every week from July 2016 to July 2017 as shale producers flooded the market.
However, rising interest rates mean repayments have effectively doubled, which could tip the more fragile producers into bankruptcy (the rig count has already begun to steadily fall in recent months). With this supply removed from the market, prices would subsequently rise.
A further factor that could result in rising prices is the continuation of OPEC (Organization of the Petroleum Exporting Countries) cuts. OPEC introduced output caps in January 2017, limiting production levels for member countries. Although the cap is set to end in March 2018, OPEC is due to meet at the end of November 2017, with the general expectation that it will again agree to extend the cap until the end of 2018.
Compliance with such agreements has historically been poor, but things seem to be different this time, with monthly compliance targets 98 per cent fulfilled and even exceeded in March, April and May. If OPEC members continue to toe the line, we should see prices rise due to diminished supply. Additionally, with conventional exploration from non-OPEC oil companies halted (lack of money/political pressure), there are not many likely candidates looking to use this as an opportunity to gain market share.
Tensions Remain High
Geo-political tensions are at their highest in recent years, with all eyes on North Korea’s worsening relationship with the US. There are also increasing fears of further escalation of conflicts in the Middle East – travel warnings have been issued in Bahrain, Kuwait, Saudi Arabia and the UAE (United Arab Emirates) – indicating heightened instability. Any destabilisation in this area would have a profound effect on oil prices.
Adverse weather caused a price spike at the end of the summer this year (the start of the North Atlantic storm season), with flooding resulting from Hurricane Harvey knocking US production offline for two weeks. Consequently, demand for refined products from Europe, Middle East and Asia increased, triggering a spike in prices. Should history repeat itself in 2018, we could see another rise around September (although the weather is even harder to predict than the oil market).
All the factors above affecting supply are set against a backdrop of increasing demand. World oil consumption has increased year on year since 2009 (post financial crisis) and is set to do so again in 2018. The consequence of any diminution in supply in a landscape of growing demand means price rises.
Expect the Unexpected
However, experience tells us to expect the unexpected when it comes to predicting the future. There are a number of conceivable scenarios that could temper increasing prices: US shale oil producers could find a way to survive through adversity as they did in 2014, OPEC members could break rank and begin to ramp up production and tensions in the Korean Peninsula could dissipate, should for example China force Kim Jong-un to moderate his nuclear position. Overall though, the signs are pointing to a continuation of recent upward trends, and a fair summary would be that prices look more likely to lie at $75 per barrel than $55 per barrel by the end of 2018.
This article originally appeared in the December 2017 edition of the Freight Transport Association’s Freight & Logistics magazine.