|06 February, 2019

Oil tugged and pulled by conflicting fundamental themes

Lukman Otunuga is a research analyst at FXTM. A keen follower of macroeconomic events, with a strong professional and academic background in finance, Lukman is well versed in the various factors affecting the currency and commodity markets. Lukman holds a BSc (hons) degree in Economics from the University of Essex, UK and an MSc in Finance from London School of Business and Finance, where he studied corporate finance, mergers & acquisitions and the role of international financial institutions.

Website: www.forextime.com

Bad news from Venezuela already largely priced in, and U.S. supplies continue to flourish

The outlook for Oil in Q1 is dominated by a set of drivers which appear to offset each other, leaving black gold on what seems to be an evenly-balanced scale. On the bullish side of the oil price, Venezuela’s woes have worsened now that the United States has imposed sanctions on the country’s public oil company, PDVSA. While it’s true that investors have largely priced in the impact of Venezuela’s problems, buying trends can still be triggered when there are new and negative headlines.

On the bearish side, U.S. supplies are still abundant, keeping inventories well stocked with little sign of slowing down. Whenever the bulls claim support from OPEC’s supply cuts, the bears point to the US-Sino trade dispute and economic slowdown in China.

Fierce counter-play between bullish and bearish factors has seen oil range-bound since late Q4. Looking ahead to the next two months, there’s little reason to expect dramatic changes barring a black swan event or a return of geopolitical tensions. Even a positive end to the trade negotiations between China and the US could take six months to a year to refuel growth back into the Asian giant’s economy.

There is one new factor which could tilt the scales either way – a weaker U.S. dollar (USD).  Federal Reserve dovishness has unexpectedly flown back onto the market scene, raising the prospect of a more affordable exchange rate versus other currencies. For USD-denominated oil this could mean a couple of different scenarios. In one scenario, bargain hunters take the opportunity to snap up big contracts, boosting demand. For as long as there is a relatively plentiful oil supply, the effect may be that the price sees minor temporary dips as per supply-demand fundamentals. In the case of a supply shortage for any reason, there could be temporary rises in price as investors seek to capitalize on a weaker USD and lock in their oil contracts.

What it means for the Gulf is that oil exports may pick up due to a more favourable and affordable USD exchange rate against other currencies. Provided that OPEC maintains its policy of reduced supplies, the weaker USD could be the source of price volatility for oil in the first quarter.

As mentioned earlier, there’s a caveat to the balance between bullish and bearish drivers. An unfavourable scenario where geopolitical tensions intensify and China’s economy continues to decelerate could mean bad news for oil prices. In this situation, OPEC may need to take more dramatic supply-cut measures and the Gulf states might have to consider supportive measures for their economies. In the best-case scenario, China and the US settle their trade differences, reducing fears over a global slowdown and brightening prospects for oil. The Gulf states could then focus more on challenging the U.S. for a share in the global oil markets.   

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