Whilst the sharp fluctuations in oil prices, CSI experts analyzed the main driving forces that affect the oil market. With relatively stable demand, supply factors come to the fore of the attention.

After rising from the summer of 2017 and peaking at $86 per barrel at the beginning of October 2018, the price of Brent crude oil underwent a noticeable correction, falling by about 40% by the end of 2018 (see Chart 1). A similar correction occurred five years ago. Oil prices plummeted in 2014 after a period during which Brent crude traded at around $110 per barrel. And in January 2016, prices fell to less than $30 per barrel. Changes in oil supply sources have become an important factor in rising oil prices since the advent of shale oil in the United States.

Since 2011, the US shale oil production capacity has expanded significantly, allowing the United States to compete with the two largest global oil producers, Russia and Saudi Arabia, in terms of daily production. The development of production technologies and investments in pipeline systems and railway capacities have allowed US producers to expand production, which has made the US an important driver in the global oil supply. Between 2011 and the summer of 2014, the US share in the aggregate supply increased significantly (see Chart 2).

At the end of 2014, members of the Organization of Petroleum Exporting Countries (OPEC) changed their strategy by abandoning oil quotas in an attempt to regain their market share and, according to some market analysts, crowding out US oil supply, lowering oil prices below the level at which US shale oil producers can be profitable. OPEC’s actions led only to a short-term reduction in shale oil production. At the end of 2016, OPEC had to reconsider its approach, since a decrease in global demand led to a further decrease in oil prices. The OPEC strategy put pressure on the public finances of its members, and indicators of fiscal sustainability in the period 2014-2016. sharply worsened for most OPEC countries. As oil prices began to rise again in 2017, US producers quickly regained their market share.

The latest fluctuations in oil prices by the end of 2018 were caused by significant changes in the market assessment of the prospects for oil supplies. Despite U.S. production growth, oil prices rose during the first three quarters of 2018, as market participants focused on lowering production in Venezuela and the prospects for Iranian exports to decline after the U.S. withdraws from the 2015 Iranian nuclear agreement. In May 2018, the United States announced that, starting in November 2018, they would again impose sanctions on the export of Iranian oil. By October 2018, Iranian oil exports had already declined by about 0.35 million barrels per day.

At the same time, the market was worried about whether OPEC would respond by increasing production to compensate for the loss of Iranian products in world markets. However, since the beginning of October there has been a noticeable correction in prices. Saudi Arabia and Russia have given assurances that they will indeed increase production, if necessary, after the imposition of sanctions. Further downward pressure was exerted by the decision of the US government to provide six-month exemptions for oil imports to key Iranian consumers. At the beginning of December 2018, OPEC, together with the largest manufacturers that are not members of OPEC, agreed to reduce production. However, there were doubts as to the extent to which members would comply with the conditions for reduced production. Consequently, the decline in oil prices did not stop until the beginning of 2019 after the initial figures for December indicated a significant decrease in production at OPEC.

Further support for the oil price should be provided by the extension until March 2020 of the OPEC+ agreement on reducing the total oil production by 1.2 million barrels per day relative to the level of November 2018, starting from July 1, 2019.

The growth in aggregate oil demand in recent years has been more stable, but is expected to decline by the end of 2019. Over the past decade, energy consumption in countries that are not members of the Organization for Economic Co-operation and Development (hereinafter referred to as the OECD), especially in China, has been the main driver of global oil demand (see Chart 4). However, demand growth in emerging and developing economies has been balanced by slowing demand in OECD countries. Recently, when economic growth in emerging and developing economies has slowed somewhat, there has been some similarity in oil demand growth in OECD and non-OECD countries.

The role of OPEC and other major producers cooperating with OPEC remains an important factor in the dynamics of oil prices. Extra-large oil producers, such as Saudi Arabia, still play an important role. Nevertheless, the OPEC strategy to lower oil prices in 2014 and 2015 was not able to suppress shale oil production in the United States, which indicates a decrease in OPEC’s ability to stabilize prices at the desired level over longer periods of time. While traditional production methods are usually cheaper than shale oil, most oil-exporting countries need higher oil prices to balance their public sector budgets. However, the shale revolution helped limit the increasing pressure on oil prices, as US production tends to rise when prices exceed the break-even level. According to an energy study conducted by the Federal Reserve Bank of Dallas, the operation of existing wells can be profitable in the price range of 25-35 US dollars per barrel.

In general, the shale revolution has changed the structure of the oil market. OPEC strategies should now take into account the reaction of shale oil producers. Competition from shale oil producers may reduce the ability of traditional oil producers to raise prices above a given level over long horizons. At the same time, the process of adapting OPEC strategies to a new source of competition has led to some volatility in oil prices in recent years. Given that oil price volatility will continue in 2019, the CSI team examined a number of factors and identified the most likely triggers that, in our opinion, will affect the price of oil in 2019-2021.

The main factors that will affect the price of oil in 2019-2021

1. Demand

Market demand is the main driver of oil prices and in case of signs of weakening demand, the price of oil will decline. Forecasts regarding demand are mostly negative. Thus, OPEC lowered its forecast for oil demand growth by 100,000 barrels per day. Goldman Sachs also lowered its forecast for oil prices due to concerns about oversupply and relatively low demand. These forecasts indicate a possible decrease in demand, which will negatively affect prices over the entire period.

2. The economic situation in China

China is the largest exporter and the second largest country in terms of imports in the world (after the United States), this fact has a strong influence on the global economy. Today, a big uncertainty is formed by the trade war between the USA and China. The negative impact of external circumstances slows down industrial production in China, and forecasts of GDP growth look disappointing. The Chinese stock market received the title of the worst stock market in 2018, thanks in large part to the trade war. Inflation among manufacturers is also troubling in China, rising by only 0.9% compared with growth expectations of 1.6%. If in 2019 the most important consumers in the world see a slowdown in economic growth, both the global economy and oil markets will suffer.

3. Global crisis and financial instability

We are currently in the longest bull market in history, and this fact can be considered a cause for concern. In 2018, sales on the US stock market repeatedly occurred due to fear of the financial crisis, slow growth and a trade war. In 2019-2021, close monitoring of the state of the world economy should continue. The US yield curve, a time-tested measure of forecasting recession, has flipped over again. The inverted yield curve is a bad omen for both the global economy and the oil market.

4. Geopolitical Factors in the Middle East

Due to the compact location of the largest oil fields, the Middle East is considered a rather important region, and any tension in the region can seriously affect oil prices. It is also noteworthy that the events around important logistics hubs, which play a key role in the transportation of Middle Eastern oil, also influence futures quotes. So, events in countries that control, for example, the Strait of Hormuz, significantly affect prices. According to Lloyds, the strait accounts for up to 40% of world exports.

5. Maritime regulations 2020

The International Maritime Organization (IMO) announced in 2016 a new set of rules, which should be enforced by 2020 and provides for reducing the sulfur content in “all types of marine fuel” from CSI Energy Outlook 23 3.5% to 0.5%. There are different opinions regarding the readiness and potential of the refinery for such reforms. According to one estimate, to fulfill these rules, it is necessary to build almost 75% of additional capacities. Moreover, the costs of this may not be offset by sales. In any case, it will be extremely important to monitor changes in the IMO 2020 rules, which could lead to a significant change in the demand for crude oil.

6. Reduction in oil production

Perhaps the most predictable and understandable factor, which, however, is losing its importance year by year. The reason is clear: American and Canadian oil workers are producing more and more oil, and the influence of OPEC is less and less. Countries included in the oil cartel meet twice a year and decide on the volume of production or, to be precise, on oil quotas. Quotas are formed for each country, but a total figure (volume) is announced. In December 2018, OPEC+ countries decided to reduce daily production by 1.2 million barrels. On July 1, the largest oil exporters included in OPEC +, following a two-day meeting in Vienna, signed an agreement to extend the deal to regulate oil production for the next 9 months until March 2020. In general, this fact may provide further support for the oil price. As of September 2019, OPEC includes 14 countries: Algeria, Angola, Venezuela, Gabon, Iran, Iraq, Congo, Kuwait, Libya, United Arab Emirates, Nigeria, Saudi Arabia, Equatorial Guinea and Ecuador. Qatar has left the organization since January 2019.

7. Sanctions on Iran

Existing sanctions against Iran and the potential withdrawal of US sanctions will remain one of the key factors in the oil markets in 2019-2020. The resumption of exceptions that have already been made for major purchasers of Iranian crude oil is far from unambiguous. Any decision to renew or cancel them will have serious consequences for oil prices.

8. Climatic factors

One of the most consistent factors affecting the price of oil is the weather. Each year in August-October, the focus of the oil market is shifting towards weather conditions in the Gulf of Mexico. The Atlantic hurricane season often makes serious adjustments to expert forecasts. The period from September to October is the peak of the hurricane season, and this is important for the industry and market players in that most of the US mining and processing capacities are located in a region that is subject to the influence of these same disasters. In other words, an impending hurricane may stop or limit production and processing for some time. Often, companies evacuate workers in advance and reduce production. For example, in 2017, hurricanes Harvey, Irma, and Nate paralyzed the operations of the Gulf of Mexico enterprises, which led to a 12% drop in US production and a decrease in refinery load at the beginning of September from 96.6% to the minimum since 2008, 77.7%. Hurricane Dorian, which occurred in August 2019, did not support oil quotes, as it passed by the main producing territories of the United States. Although this list of factors is far from exhaustive, it contains the most significant catalysts for rising oil prices, which can be observed in our next section, where we predict the dynamics of prices. Thus, the interaction between the above factors is likely to play a large role in shaping developments in the oil market in 2019-2021.

Oil price dynamics in 2019: what to expect from the global oil market?

According to the World Bank forecast for 2019, oil prices this year will average $66 per barrel and $65 per barrel in 2020. A slight downward revision of the oil price forecast is associated with lower than expected global economic growth forecasts and higher than expected oil production in the United States.

The ongoing trade dispute between the two main consumers of crude oil - the United States and China - continues to suppress rising oil prices. Although the price of oil may still rise in 2019, as OPEC makes sure that oil reserves are “under control”.

According to the OECD, “tensions in trade are damaging not only short-term, but also mediumterm prospects, which requires the government to take urgent measures to revive growth.” The current alliance of OPEC and other countries can keep oil prices afloat, by not rushing to increase production. Thus, oil prices may continue to rise as the OPEC alliance continues. Recently, OPEC and its partners once again reduced production in an effort to stabilize the oil market.

According to EIA’s Short-term Energy Outlook, crude oil production in OPEC countries will average 30.3 million barrels per day, which is 1.7 million barrels lower than in 2018. The EIA predicts a further decline in oil production by 0.4 million barrels per day to 29.8 million barrels per day in 2020. Also, according to EIA forecasts, a decrease in world oil reserves of 0.2 million barrels per day in 2019 and 0.1 million barrels per day in 2020 is expected. According to the forecasts, global oil demand will grow by 1.4 million barrels in 2019 and by 1.5 million barrels in 2020.

In April 2019, crude oil prices rose for the previous 4 consecutive months, gradually approaching a 6-month high. Despite the EIA forecast for a decrease in Iranian oil production and exports, oil supplies from OPEC and other countries seem to be able to compensate for the shortage of Iranian oil. Increased oil production is expected in the United Arab Emirates, Kuwait, Saudi Arabia and Russia.

In June-July, Brent quotes moved in the range of $60–67 per barrel. Economic indicators point to a potential slowdown in global economic growth. In turn, it can lead to a decrease in oil demand. A noticeable response among investors was not even provoked by the decision to extend the contract to reduce production at OPEC+ (July 1). In August - the first trimester of September, Brent quotes were already in the range of $55–64 per barrel.

According to RBC news for July, JPMorgan analysts believe that in the third quarter, oil prices may reach an average of $67.33 per barrel. BNP Paribas analysts are even more optimistic. The French bank predicted the growth of Brent quotes to $ 76 per barrel by September of this year.

According to the EIA forecast, the price of Brent crude oil in 2019 will be $73 per barrel, which is $5 more than previously predicted and will drop to $67 per barrel in 2020.

Given the pricing factors listed in the previous section, CSI analysts forecast that oil prices can vary in the range of $52-92 per barrel in 2019-2021 with an average of $65, $69, $72 per barrel by the end of 2019, 2020, 2021 , respectively (see Chart 5).

What will happen in 2019-2020 in oil exporting countries?

Oil exporting countries are heavily dependent on energy revenues to finance their economy as a whole, including the allocation of subsidies to address priority issues in these countries. Thus, the break-even points of the budget of oil countries are more important for world energy prices than the sale of a barrel of oil by large oil companies, which must finance capital expenditures and pay dividends to shareholders.

The breakeven point differs in each country depending on the budget deficit of various oil producers. According to our expectations of oil prices, as well as statistics from the International Monetary Fund, we have identified a number of countries that may have potential budget deficit problems with the aforementioned forecast oil prices (see Charts 6 and 7).