Lydia Powell, Observer Research Foundation
The developments in West Asia (or Middle East) in the second half of 2019 are close to what energy analysts would have described as the worst case scenario for oil markets. The gross peak supply loss of 5.7 million barrels per day (mbpd) following the attack on the world’s largest crude processing facility in Saudi Arabia’s Abqaiq and its second biggest field in Khurais was the largest on record as it surpassed the loss of 5.6 mbpd during the Iranian revolution in 1978.[1] Roughly 5.5 percent of global oil supply was lost after the attack on Saudi Arabia which was comparable to the 5.6 percent supply loss during the six day war in 1967.[2] The immediate price increase of Brent crude by 19 percent after the attack was also largest single day increase since 1988. The attack on Saudi oil installations was followed by an attack on an Iranian oil tanker near the red sea off the Saudi Arabian coast.[3] This was not the first attack on oil tankers in the region in 2019. The surprise is that the serial oil supply shocks in West Asia did not really send the price of crude oil to unprecedented levels that the “worst case” scenarios predicted.
Roughly two weeks after the attack on Saudi oil installations, the price of Brent was close to $61.40/bbl, 10 percent lower than the peak price of $67.68/bbl soon after the attack on Saudi oil production sites.[4] Three weeks later it was about 20 percent lower than the peak. Just over a week after the attack on the Iranian oil tanker the price of Brent is about 12 percent lower than the peak in September.
One could argue that flexibility on the supply side is part of the explanation for subdued price spikes. Faster than expected restoration of supply by Saudi Arabia that drew on inventories and spare production capacity limited price increases after the attack on Saudi oil installations.[5] The rise of the United States (US) as a new source of crude supply also added flexibility to the market. This source of flexibility in supply is expected to continue for the next few years. About 4 mbpd is expected to be to global supply growth from the US till 2024 which is larger than the total supply growth from traditional producers Iraq, Norway, Brazil, Guyana and the UAE.[6]
But supply flexibility alone does not fully explain the subdued impact on prices. A “balance of risks” analysis on crude price showed that risk from slow global demand growth will, by far have the greatest impact on crude prices reducing the base line Brent price of $59.2/bbl in 2019 by about $10/bbl.[7] This is more than double the roughly $4/bbl increase in price forecast from supply disruptions in Iran or Venezuela on account of geo-political tensions and ten times the $1/bbl reduction in price forecast for the assumption of robust growth in shale oil (tight oil) production in the US.
Subdued demand for oil supressed crude prices by at least $2/bbl in the first quarter of 2019. The expectation that prices would recover in the second half of 2019 on the back of robust demand from China, slowdown in US tight oil production and OPEC+ supply reductions is proving to be overoptimistic.[8] Oil demand growth in China was 1.4 percent year-on-year between January and June 2019 compared to about 6.6 percent in 2018.[9] The economic slowdown in India is expected to reduce global consumption growth by about 100,000 bpd in 2019 which would push global growth down by 1 mbpd or less in 2019.[10] India accounted for about 18 percent of global oil consumption growth between 2013 and 2018.[11] Though reports are coming out stating that there are visible signs of a slowdown in the growth of US tight oil production, this may not be sufficient to offset the impact of slow demand on crude prices.[12]
Historically oil price shocks were driven by a combination of global aggregate demand shocks and precautionary demand shocks rather than supply shocks.[13] The surge in oil process in 1979 is attributed to both a soaring demand shock on account of global economic growth combined with precautionary demand shock triggered by increased uncertainty in future oil supplies. The price spikes in 2003 and the price falls between 2008 and 2009 as well as the decline since 2012 are also attributed to oil specific demand shocks.
Changes in ‘precautionary demand’ for oil associated with shifts in expectations about future oil supply relative to future demand is definitely supressing current price of crude. With increasing expectations of an economic slow-down in the future combined with expectation of quick mobilisation of supplies from non OPEC producers including the US, the need to hold inventories (preparing for precautionary demand) has reduced. This is adding to the pressure on crude prices.
In general, a change in precautionary demand for oil will result in an immediate, persistent and large change in the price of oil. A change in the aggregate demand for all industrial commodities will cause a sustained change in the real price of oil while a production disruption will cause a small and transitory increase in the price of oil. Policy makers in India need to understand the extent to which change in the real price of oil is driven by one shock or another before formulating geo-political and energy policy responses.
Views are those of the author
Contact: Indiaenergyinsights@gmail.com
[1] International; Energy Agency
[2] https://www.brookings.edu/blog/markaz/2017/06/05/the-1967-war-and-the-oil-weapon/
[3] https://www.reuters.com/article/us-mideast-iran-tanker/iran-decries-cowardly-attack-on-oil-tanker-idUSKBN1WR05D
[4] https://oilprice.com/oil-price-charts/46
[5] https://www.marketwatch.com/story/oil-edges-lower-as-us-supplies-build-reports-say-saudis-restoring-output-2019-09-26
[6] https://www.iea.org/newsroom/news/2019/march/united-states-to-lead-global-oil-supply-growth-while-no-peak-in-oil-demand-in-si.html
[7] Bassam Fattouh & Andreas Economou, 2019, “Oil Price Paths in 2019: Navigating Volatile Markets”, Oxford Institute of Energy Studies, (February), https://www.oxfordenergy.org/publications/oil-price-paths-2019-navigating-volatile-markets/?v=c86ee0d9d7ed
[8] Bassam Fattouh & Andreas Economou, 2019, “Has Saudi Arabia’s Balancing Act Gotten Any Easier?”, Oxford Institute of Energy Studies (May), https://www.oxfordenergy.org/publications/has-saudi-arabias-balancing-act-gotten-any-easier/?v=c86ee0d9d7ed
[9] Michal Meiden, 2019, “US-China: The Great Decoupling”, Oxford Institute for Energy Studies (July), https://www.oxfordenergy.org/publications/us-china-the-great-decoupling/?v=c86ee0d9d7ed
[10] John Kemp, 2019, Reuters, India’s Stuttering Economy hits global oil demand growth (25 September), https://in.reuters.com/article/india-oil-kemp/indias-stuttering-economy-hits-global-oil-demand-kemp-idINKBN1WA1SS
[11] BP, 219, BP Statistical Review of World Energy, https://www.bp.com/content/dam/bp/business-sites/en/global/corporate/pdfs/energy-economics/statistical-review/bp-stats-review-2019-full-report.pdf
[12] Christopher M Matthews & Rebecca Elliott, 2019, “Shale Boom is slowing just when the World needs oil most”, Wall Street Journal (29 September), https://www.wsj.com/articles/shale-boom-is-slowing-just-when-the-world-needs-oil-most-11569795047
[13] Lutz Kilian, 2009, “Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market”, The American Economic Review Vol. 99, No. 3 (June), pp. 1053-1069
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