Oil prices seemed to have leveled off after seven consecutive weeks of weekly declines, the longest streak in years. But the next steps are unclear. In the battle over the market narrative, concerns about the health of the global economy are up against the potential for serious supply outages in Iran. A lot could change by the end of this year, but as the summer draws to a close, it isn’t clear which narrative will win out.
The fears about the global economy have moved to the front burner in recent weeks. The trade war between the U.S. and China still threatens to drag down global growth, although the news that the U.S. and China will resume talks this week for the first time since June seemed to buoy the markets. But the talks will be conducted at a lower level – the U.S. point person is an undersecretary at the Department of Treasury, not Secretary Steven Mnuchin, which raises questions about the authority to ink a deal.
More importantly, Treasury isn’t even the agency that leads on trade. That adds up to U.S. and China essentially keeping their lines of communication open, but not actively seeking a resolution in any big way, at least not from this venue.
But the talks at least increase the odds, however slightly, that the proposed $200 billion in U.S. tariffs on Chinese goods do not go forward. The U.S. Trade Representative is holding a six-day process beginning this week to look at those tariffs.
Meanwhile, the meltdown in Turkey’s currency, the lira, has set off a different source of trouble. The turmoil spread to other emerging markets, dragging down a whole host of currencies.
Weaker emerging market currencies threaten to seriously slow down demand – not just for oil, but for a range of commodities. The Bloomberg Commodities Index has declined by 3 percent this month and by more than 9 percent in the last three months. Oil prices are down by more than 10 percent since May. Of course, commodity prices might get wiped out, but the slowdown would also be true of the global economy.
“Other emerging markets have already been hit, evident through depreciating currencies, investors demanding higher yields on emerging market debt and a jump in credit default swaps on this debt,” ING wrote in a note. “However saying all of this, the US Federal Reserve seems unlikely to deviate from its plan for tighter monetary policy, which should remain supportive for the U.S. dollar, whilst growing emerging market risk adds further support to the currency.” If the Fed doesn’t let up, then the pressure on currencies around the world will continue.
It is hard to imagine that such a scenario doesn’t directly translate into a significant downward revision in global oil demand. After all, oil is priced in dollars, so a stronger dollar (and weaker currencies elsewhere) means that oil is vastly more expensive. That is especially true if oil prices are not falling (it used to be the case that the dollar and oil traded inversely, but that relationship has weakened recently).
The IEA is, for now, sticking with its forecast of oil demand growth at 1.4 million barrels per day (mb/d) for 2018. Brent oil prices are up 7 percent this year, but in local currencies the price increase is much bigger. In Turkey, oil is around 75 percent more expensive, and there has been a similar increase in Argentina. In Brazil, Russia and South Africa, oil feels about 20 to 25 percent more expensive this year, even though oil has only climbed by about 7 percent, according to ING. In Hungary, India, Poland, Chile, Indonesia and the Philippines, oil is 15 to 20 percent more expensive. And on and on.
Price increases of that magnitude will surely cut into demand. But the picture gets muddied when governments step in to shield their countries from those price increases, ING says. In Brazil, the government decided to re-regulate fuel prices to stave off crippling protests. Indonesia announced $4.8 billion in subsidies to keep prices from rising. Malaysia also decided to fix fuel prices for the rest of 2018. These price supports could blunt the price signal from both higher global oil prices and weaker currencies, keeping demand from falling by more than it would otherwise.
Still, the story is bearish for crude. We have different things happening at the same time – the global economy is slowing (the end of synchronized growth), the U.S.-China trade war potentially acting as a major headwind and emerging market currencies dragging down demand.
The oil supply picture remains in flux, with the potential outage of 1 mb/d of Iranian supply looming. But the demand side of the story suddenly looks pretty negative.
By Nick Cunningham of Oilprice.com
