Where is Oil Headed?

Brian Hicks

Written By Brian Hicks

Posted October 8, 2013

The direction of oil prices is always contingent upon a number of outside factors, primarily geopolitics. But we don’t need to get into a long, wonky debate about foreign policy.

Here’s what you need to know.

When it comes to Brent crude, prices have been relatively stable despite spikes amid turmoil across the Middle East. Western intervention in Syria was halted when Prime Minister David Cameron’s intervention proposal was voted down in Parliament. President Obama was facing similar rejection in Congress.

oil drillingBecause of Russian intercession and ongoing talks, U.S. intervention in Syria seems to have been averted – at least for the time being.

But Egypt is another country to keep an eye on, as protests and killings continue to plague the country. If further unrest spins out of control, the military may seriously consider shutting down the Suez Canal despite past commitments to preserving passage security.

Pay attention to the fracturing of Libya as well and its decline in oil production due to strikes and security issues. Iraq also seems to be more unstable than ever, seeing its highest levels of terrorism and violence since 2008.

Despite all of these negative factors, oil traders have come to expect this level of instability in the region, and Brent has leveled off as a result.

On Monday, Brent prices were at $109.46.

There is speculation oil prices may decrease rather than spike due to record production across North America. This would especially have an impact on WTI, and if the U.S. were to enter the oil export market, many expect prices would move even lower across the board.

But I would not be too optimistic about this assessment. Let’s keep in mind the strategic political scheming that can cause more Middle East chaos.

The Effects of Conflict

Despite Syrian President Bashar al-Assad’s agreement to destroy stockpiles of chemical weapons, there are too many interests at play that want to see him overthrown. Let’s remember that former Libyan leader Moammar Khadafi destroyed his weapons during the Bush administration, and we all know how his fate turned out.

Bottom line: certain Western interests want Assad gone because many seek to take down one of Iran’s remaining allies in the region.

The Gulf states want a gas pipeline into Europe to displace Russia’s monopoly. In the past, Qatar has called its funding of Syrian rebels an “investment.”

No matter which way you slice it, there will be further determination to remove Assad in some other form – a factor which could easily cause a spike in oil unless Russia intervenes.

And then there’s Iran.

New President Hassan Rouhani seems to be making a more conciliatory gesture toward the West regarding the country’s nuclear program, but hardline factions within Israeli and Western establishments are determined to take down Iran no matter what. The question remains if these factions will prevail in overthrowing Assad and eventually stoking further conflict with Iran.

If that is the case, we could see oil rise to as high as $150 – especially if the Strait of Hormuz closes.

Oil Price Estimates

But let’s assume wider conflict does not occur. There will be some stabilization within the energy market and periodic fluctuations as tensions continue, but nothing too high.

In early 2013, Credit Suisse forecast average Brent prices at $115 for the year, while Barclays Capital believed prices would surge to $135. Credit’s analysts is proving to be more accurate, and I don’t see a scenario in which prices would drastically surge to the $130 range for the rest of the year, unless geopolitical standoffs become more inflamed. We have already seen prices soar to $116 earlier in the year, and I expect this number to be the maximum as the year plays out.

In 2012, Brent averaged around $112, and 2013 has followed the same trend thus far – mostly due to the same issues: Iran, Syria, and world economic downturn.

But I would reserve the $135 figure for 2014, since there are a variety of unknown factors – such as wider conflict and political unrest – that could very well cause spikes in the market.

If this does not happen, many analysts believe prices could plunge to around $80 a barrel. Here are some things that could make this happen.

Lower demand in developed nations could play a role. This is already causing Russia to look East. Russia’s Siberian ESPO benchmark could become the new standard for Asia, as the former Soviet nation gains more business and economic ties to the region.

We could also see more nations joining the shale production craze within the decade.

But the most important factor in lowering prices across the board is the domestic production boom in the United States.

This has caused Saudi Arabia to lower its production estimates for the coming years, but with rising demand in China and India, OPEC will not go out of business anytime soon. The developed world is still OPEC’s most important consumer, and this could have a drastic effect on prices as North America ramps up production or if other nations welcome domestic production.

WTI Crude

We’ve seen WTI crude prices catching up to Brent on the energy stage, with the two sometimes only a few dollars apart. This is a positive trend, given WTI’s recent failure to catch up to Brent ever since Saudi Arabia established the Brent benchmark as the dominant international standard.

The narrow spread is attributed to a greater number of pipeline projects and the relief of supply gluts in Cushing, Oklahoma – the primary factor that has caused WTI to fall behind. On Friday, WTI was at $103.84.

WTI prices are falling behind because of the government shutdown, which has not only sparked uncertainty in the energy market, but has also caused lower demand for oil as non-essential services have been cut.

Production in the Gulf was virtually cut in half in preparation for Tropical Storm Karen, CNBC reported. Evacuations were in place at the end of last week, and numerous platforms were shut down.

Analysts believe America could start exporting oil within the next five to ten years. And exporting oil would have to be part of the equation in order to keep domestic price depreciation at bay. Saudi oil Minister Ali Al Naimi believed prices staying at $100 and above is the ideal scenario in fostering production and bringing “stability” to the market.

If prices fall below $100, OPEC could try to place caps on production to bring prices back up. But this can prove to be more difficult than before, since Iran’s energy economy has suffered a setback due to sanctions, and Iraq has taken Iran’s place as OPEC’s second largest producer. Despite Saudi Arabia’s lowering of production, Iraq has become increasingly independent and may not play ball if the Saudis want to cap production.

But in this case, Iraq’s Shia-led government could be influenced by Iran, since the Persian nation has called for lower OPEC production in the past to keep prices higher.

In the pre-Arab Spring days, leaders needed oil prices to remain high in order to fund public services and quell potential civil unrest. Although revolutions and invasions have led to a removal of some of these dictators, like Saddam and Khadafi, autocratic regimes like Saudi Arabia still depend on high oil prices to appease population discontent, which is increasingly bubbling to the surface in the Kingdom.

How to Play Oil

I would bet on oil going higher in the coming years.

Despite predictions of oil plummeting to $70 or $80, I believe prices will stay around $100 for 2014 and beyond. But the U.S. could surprise everyone in the next five years by entering the oil-export market – if we can get passed the inevitable political outcry that will stem from this issue.

As countries like Iraq, Afghanistan, and Libya learn to live under new regimes post Western invasion, there will certainly be levels of chaos and instability, which will keep traders nervous and prices high going forward.

And there are too many vested interests that seek to keep oil prices at $100 a barrel and above, whether that is through capping production or just altogether rigging the energy market.

I envision a scenario of prices stabilizing to around $110 and inching up as political and social turmoil heightens. And prices will soar to $140 and above if profound events occur in the Middle East.

Only time will reveal which scenario plays out.


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