Is now the time to hedge against an oil price rebound? The last time we asked this question was in mid-April 2013, shortly after Brent crude prices dropped below $98 per barrel. At the time prices had fallen due to stronger oil supplies from the North Sea, concerns over poor crude demand and reduced geopolitical risks.
Brent Oil prices quickly rebounded reaching almost $117 per barrel just four months later as the prospect of military intervention by the US in Syria and the threat of disruption to other Middle East oil producers grew. Brent crude then traded in the $105-$115 per barrel window for the next year.
Since mid-June Brent crude prices have declined by over 15% and has now traded below $100 per barrel for the past seven days. But will oil prices now rebound again?
First, geopolitical concerns have not gone away. This week the 250,000 b/d Sharara field, representing 30% of Libya’s oil production was shut following a rocket attack at the connected Zawiya refinery. With the political situation in the country still fluid the risk of unplanned disruptions to supply is still high.
In addition oil workers in Nigeria began striking on Tuesday over a disagreement with the government over pensions and a lack of crude supplied to refineries. Although it is thought that the strike is unlikely to affect crude exports unless it spreads to private oil companies.
Although risks remain geopolitical risks in the oil market appear to demonstrate a degree of seasonality by escalating early in the year. Oil prices tend to react to a geopolitical event and the prospect of a shortage by moving sharply higher initially and then gradually declining if nothing happens to output.
Recent unplanned disruptions to oil production have been countered by a broadly equivalent increase in US output as a result of rising shale oil production, to some extent neutering the impact of disruption elsewhere.
Second, OPEC may respond to weaker prices. The $100 per barrel mark is a key break-even point for a number of large oil producers including Abu Dhabi, Nigeria,Iraq and Russia. Saudi Arabia’s break even point is thought to be nearer $85 per barrel, however it is only the kingdom that is in a position to restrict output in any great degree.
Saudi Arabia’s reduced output by 400,000 b/d in August to 9.6 million b/d, the largest since December 2012. According to estimates from BofA Merrill Lynch a 10% drop in oil prices has historically led to an average 1.5% reduction in Saudi production 3 months later. The 15% decline in oil prices has now been followed by a hefty 4% decline in Saudi output.
Third, the decline in oil prices may spur an increase in economic activity which could ultimately cause a rebound in oil demand and prices. A favoured rule of thumb is that every $10 per barrel increase in the price of oil ends up cutting global growth by about 0.2 percentage point – this affect works both ways.
Recent attention has focused on weak Chinese crude imports. To some extent this apparent slowdown was expected as China had aggressively imported crude to fill its strategic oil reserves early in the year.
As SocGen concludes:
While we expect a near-term stabilisation in Brent prices, we do think that it will take several months for Saudi supply cuts and stronger Chinese demand to bring elevated crude oil stocks down towards seasonally average levels.
Taken together with the observation that historically oil prices tend to weaken between September and the end of the year and that oil market geopolitical concerns tend to spike in the spring, oil prices are now unlikely to see a similar strong rebound in prices until next year, remaining near $100 per barrel.