The Fear Driven Oil Price Rally Won’t Last

Over the past week, oil prices have trended higher as concerns about escalating U.S.-Iran and Iran-Saudi standoffs have overshadowed bearish-side concerns about the U.S.-China trade war and slowing global economic growth.

The rising tension in the Middle East and the critical oil tanker waterways in the region have had some analysts and investment banks return to talking about Brent Crude hitting US$80, US$90, or even US$100 a barrel, compared to the current level of around US$72 per barrel.

JP Morgan, however, thinks that the return of the geopolitical risk premium in oil prices could be only for the short term, as U.S. shale production continues to grow, while global oil demand may falter amid uncertainties in the world’s economy.

"It’s difficult to make a case why oil prices materially move up from here," Scott Darling, head of Asia Pacific oil and gas research at JP Morgan, told CNBC on Monday, although he admitted that right now it’s okay to consider risks of supply outages, given the current geopolitical situation.

U.S. shale has dramatically cut the market cycle for oil, so the geopolitical risks could be short lived, Darling told CNBC.

JP Morgan sees Brent Crude at US$75 a barrel by the end of June, but expects the global oil benchmark to average US$71 this year and to slump to US$60 in 2021, according to Darling.

At the beginning of this month, just as the U.S. sanction waivers to all Iranian oil buyers expired, Christyan Malek, head of EMEA oil & gas research at JP Morgan, told Bloomberg that Brent Crude prices could move toward the US$80 handle at some point this summer, due to stronger fuel demand in the summer and OPEC being "far more measured" in terms of their response to the end of Iranian waivers and Venezuela’s plunging production.

A week after the end of the U.S. sanction waivers for Iranian customers, Helima Croft, Global Head of Commodity Strategy at RBC Capital Markets, said that "The possibility of Iran recommencing its nuclear program and tensions around key strategic waterways such as the Strait of Hormuz and the Yemeni coast could lead to Brent crude, projected to average $75 a barrel for 2019 pass $80 mark this summer."

Last week, attacks on Saudi oil infrastructure supported oil prices and raised the geopolitical tension, leading to some investment banks projecting much higher oil prices this summer.

If the U.S. and China settle their trade dispute, thus brightening the outlook for global economy and oil demand, one incident in the tense Middle East region could result in oil prices shooting up to US$100, Francisco Blanch, head of global commodities and derivatives at Bank of America Merrill Lynch, told CNBC last week. Blanch expects Brent Crude to hit US$82 this summer.

Later last week, Bank of America Merrill Lynch said that the new sulfur content regulations for shipping fuels could push Brent to as high as US$90 a barrel, but warned that an all-out trade war could send prices plunging to as low as US$50 if it leads to an economic downturn.

Amid all these conflicting signals in the market, OPEC and its allies are set to decide next month how to proceed with their oil supply management policy—whether to extend the production cuts in some form, or to reverse all or some of the cuts.

OPEC is not rushing into decisions to reverse the cuts as it did last year in the run-up to the U.S. sanctions on Iran, just to see oil prices crashing in Q4. The cartel is said to be considering extending the production cuts through the whole of 2019, although quotas may differ, to prevent another oil price crash that would hurt the budgets of many OPEC members, including the de facto leader Saudi Arabia.

"The bottom line is that none of us wants to see the stocks swell again, so we have to be cautious. It is one of our most critical priorities," Saudi Energy Minister Khalid al-Falih said at a panel OPEC/non-OPEC ministerial meeting this weekend.

"The Saudis seem keen to extend the production cut deal into the second half of this year, in order to 'gently' draw down inventories," Warren Patterson, Head of Commodities Strategy at ING, said on Monday. ING believes that OPEC+ doesn’t need to extend the agreement in its current form, as the market will see significant tightening as we move into the third quarter.

OPEC and its Russia-led non-OPEC allies will sit down to decide the fate of the deal just over a month from now, during which geopolitical risks and demand forecasts will fight for dominance in setting the sentiment in the oil market.

By Tsvetana Paraskova for