Economic Insight: Oil - Beyond geopolitics?

  • The peak may be behind us. A number of the drivers underlying recent oil price strength could diminish in strength or reverse.  A currently elevated geopolitically induced risk premium might shrink once actual market flows become clear. Financial positions might shift towards a less bullish stance. It is our view that the peak of the economic cycle is behind us. Further, high oil prices by themselves could have a restraining impact on demand.  There will be supply side response. Substitution is encouraged.

  • Base case USD 72/bbl. We assume 2018 GDP growth of 3.3%, 2.5% USD appreciation, a return of financial net long positions to their two year average, and 0.5mbpd supply loss on the assumption that most of the loss from Iran will be mitigated while Venezuelan production shortfalls will not. Opec has about 2mbpd of spare capacity and there may be room for marginal growth from US production. Our sensitivity analysis shows upside to USD80/bbl in a bull and downside to 67/bbl, in a bear case.

  • 2019 central forecast USD 69/bbl assuming 3.1% global GDP growth, 2.5% USD appreciation and 2mbpd oil supply growth on the basis of a strong likelihood of some OPEC production increase, and US shale production becoming debottlenecked in H2 19.

  • Sector impact. A number of sectors are now finding themselves with increased input costs. These are notably speciality chemicals, airlines, shipping, road transport, mining and the heavy industry and manufacturing sectors. We see margins sustained in those sectors with pricing power, notably speciality chemicals, pockets of the machinery sectors and tight base metal segments. We see risk of margin contraction for airlines, certain shipping routes and metals characterised by over-capacity, notably steel. Expectations for persistent oil price strength are likely to lead to accelerated EV adoption. The oil and gas sectors across the value chains are seeing positive capacity utilisation, earnings and cash flow impacts. Oil prices above USD 75/bbl increase viability, adoption, development and financing prospects for alternative energy, new technologies and substitution processes. These sectors could emerge with new strength following a period, during which weak oil prices forced efficiencies and tight focus on financial sustainability.