Oil prices should rise above the $65-$70 per barrel range they have been hovering at for the last several weeks. The markets have become comfortable with the supply side thanks to the US’ “perpetual” crude oil production machine, although roughly 2.5m barrels per day (bpd) of crude output is in danger of being disrupted in Libya, Venezuela, Iran and Russia. On the other side of the equation, uncertainties over US-China relations have cast a pall on the outlook for the world economy and crude oil demand. While unfolding events may not have any impact in the short run, if indeed at all, OPEC/non-OPEC spare capacity, at 2-2.5m bpd, is limited. Any outage will stress the world oil markets – particularly the Saudis – who have pledged to make the market whole in the event of any disruption.

For 2019, global demand growth forecasts hover around 1.3m bpd, roughly met by global supply growth expectations of 1.4m bpd, including the US’ 1.3m bpd of crude oil output increases. The supply numbers include declines in output in Venezuela and Iran, new supplies from Brazil and restrained OPEC (read Saudi Arabia) production. Overall, the current market price reflects investor sentiment that the oil markets are expected to be comfortably balanced. In fact, given the continuing US output surge and the worrisome US-China dispute, the dominant bias among oil traders seems to be that oil prices should be in an even lower range – somewhere between $55 and $66 per barrel.

The market reacts to rising US-Iran tensions

The most bullish factor looming over the market is the US’ escalation of pressure on Iran. The number of barrels at risk from direct attacks on oil production, processing and transport facilities, and shipping routes is unmatched anywhere else. Added to that is the fact that the Gulf is where virtually all of the world’s excess capacity resides. The events of the last several weeks, namely, US sabre-rattling, the movement of US warships and missiles into the region, counter threats by Iranian officials and actual damage to tankers and oil pipelines, should have led to a major spike in prices.

The only explanation for the market’s tepid response is that it believes the US is posturing and that, despite his bluster, Trump remains averse to engaging militarily with Iran and will rein in his more hawkish National Security Advisor John Bolton. There is also a sense that Iran is too sophisticated, cautious or cowed to overstep into war. While the market does believe that Trump will put an end to import waivers this time, taking 1m bpd or more of Iranian crude off the market, it appears to be confident that Saudi Arabia and other producers can fill the shortfall. The fact that replacing Iranian barrels means less global spare capacity has not animated the market.

Libya, Venezuela and the potential for supply disruption

The possibility of a civil war engulfing the Libyan oil sector following the attack by the Libyan National Army on Tripoli elicited a more bullish, albeit short-lived, response from the market in early April. However, at the May 19 meeting of OPEC + ministers in Jeddah, Libyan National Oil Corporation chief Mustapha Sanallah’s surprise announcement that Libyan output had risen to 1.3m bpd, above the most optimistic expectations of around 1m bpd, reduced fears of Libyan supply disruptions. The current stalemate around Tripoli has also calmed nerves.

Meanwhile, Venezuela’s unremitting slide into chaos and steady decline in oil production – output has fallen from 3m bpd to under 1m bpd over the last decade and a half and could drop below 500,000 bpd as a result of the US embargo and other domestic problems – has been discounted by the market. Even the threat of a US invasion, which is again viewed as a move favoured by Bolton but not Trump, has failed to cause a ripple because it seen as a pathway to partially restoring output currently hampered by falling investment from foreign oil companies.

US-China trade war impacts market sentiment

Instead, the most significant downwards force on the market at present is the ongoing trade dispute between the US and China, which has overshadowed even the short-term fear over the temporary scarcity of Russian heavy crude on the world market. The willingness of the US to connect trade with security issues, which could rupture the global trading and financial system, coupled with increasingly harsh rhetoric on trade from both the US and China over the past year, has had a profound impact on market sentiment.

The market’s bearish bias has also blinded it to strong short-term crude oil demand prospects in China. The tendency of analysts to attribute “missing barrels” in their global balances to Chinese inventory building has been a consistent problem over the last few years. Chinese refiners are, in fact, consuming more crude to meet strong domestic demand for gasoline, diesel, jet fuel and petrochemical inputs. The rise of the new independents – not state-owned refiners – and petrochemical companies has been a major force in boosting crude demand in China and should not be underestimated in the near term.

Saudi Arabia key to future oil price movements

In light of these contradictory developments, Saudi Arabia’s energy minister has cautioned his OPEC colleagues and his counterpart in Moscow to continue supply restraint. He has also responded to Trump’s call for assurance that the Saudis will cover his back on Iran while firmly resisting pre-emptive production moves after being “burnt” by Trump’s surprise ending of Iranian waivers last fall. The Saudis are determined to keep oil prices at around $70 per barrel or perhaps higher, given that the kingdom’s output is well below quota and even lower than 10m bpd. Ultimately, it will be their market management in the next year – offsetting supply disruptions and meeting new demand – that will be a critical factor in understanding oil price movements. So what else is new?