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Alex Kimani

Alex Kimani

Alex Kimani is a veteran finance writer, investor, engineer and researcher for Safehaven.com. 

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Are Oil Markets Underpricing Geopolitical Risks?

  • Oil prices have gained some upward momentum in the last week, driven by geopolitical tensions and inventory drawdowns.
  • Analysts continue to debate just how serious the geopolitical risks are and whether spare capacity and new production will be able to counter supply issues.
  • Seasonal shifts in demand, coupled with anticipated interest rate cuts, look set to push oil prices higher in the near future.
Tanker

Oil prices have achieved limited upward momentum over the past week, with WTI crude gaining 4.67% to trade at $76.84 per barrel, while Brent has notched 4.29% higher to trade at $82.08. A bigger-than-expected inventory draw in U.S. inventories as well as the escalation in geopolitical risks over the past week are largely to thank for the rally. Last week's data by the Energy Information Administration showed that U.S. crude stockpiles tumbled by 9.2 million barrels last week,  driven by a big drop in U.S. crude imports as winter weather shut in refineries and lowered driving activity. Meanwhile, Yemen's Houthi leader has vowed to continue targeting ships linked to Israel unless aid is provided to the Palestinian people living in Gaza.

"We are finally seeing energy markets wake up to the distinct possibility that these supply chain disruptions will rumble on for months yet," Joshua Mahony, chief market analyst at Scope Markets, has told Reuters.

Wall Street cannot seem to agree on how serious the geopolitical risks facing the markets are. A couple of days ago, HSBC Global Research predicted that spare production capacity by OPEC+ will suffice to offset current geopolitical risks, adding that Brent crude prices are likely to remain range-bound at $75 per barrel to $85 per barrel in the mid-term. According to the analysts, OPEC+'s spare production capacity will increase to 4.5 million b/d at the end of 2024, up from 4.3 million b/d at the end of 2023, enough to dampen price spikes. Additionally, HSBC has pointed out that OPEC+'s strategy to influence prices through regular production cuts is gradually becoming ineffective thanks to surging production from non-OPEC members, especially the United States. U.S. crude production-- which hit an all-time high of 13.2 million barrels per day in the final months of 2023– is expected to keep growing in the next few years, albeit at a slower clip.

"Trade disruptions in the Red Sea add only a marginal premium to oil prices and no physical supplies have been lost so far," HSBC has said.

But the bulls beg to disagree. Commodity experts at Standard Chartered have reiterated their earlier position that oil markets are seriously underestimating geopolitical risks. According to StanChart, over the past week, there have been increased risks to Russian oil loadings in the Baltic, which have coincided with ongoing military action in the Red Sea. Further, there's greater uncertainty over Iranian foreign policy following a series of incidents in several neighboring countries. The analysts say that the sheer number, scale, and complexity of the geopolitical risks are likely to cause speculative shorts to become more concerned about headline risk.

StanChart points out that a big reason why the markets have continued to heavily discount these risks is simply confusion about seasonality. In StanChart's view, the market has incorrectly interpreted a normal seasonal oversupply in January as a sign of longer-term fundamental weakness. However, experts have predicted that this bearishness will lessen in the coming weeks as the markets gradually tighten seasonally. Oil markets tend to tighten significantly from late January as demand improves from its seasonal low. 

Last year, global oil demand in February on a month-on-month basis clocked in at 3.5 million barrels per day, an unusually large spike. StanChart has predicted that, in the current year, we will see a m/m increase of 2.7 mb/d to 102.25 mb/d in February, while the Energy Information Administration (EIA) is similarly bullish and has forecast a 2.8 mb/d m/m increase to an all-time high for any month at 103.62 mb/d in February.

Meanwhile, StanChart has predicted that the current global inventory build of 1.17mb/d in January will flip to a draw of 1.40 mb/d in February and another draw of 1.48 mb/d in March, largely due to the seasonal demand recovery. 

Now here's the main kicker: according to StanChart, the seasonal upswing in demand and the expected inventory draws are likely to make the markets much more sensitive to geopolitics and could trigger an oil price rally.

Further, the upcoming interest rate cuts by the U.S. Federal Reserve are also likely to be bullish for oil prices. Rates have been climbing in the new year due to uncertainty regarding the timing and magnitude of the hikes, leading to the dollar gaining serious momentum and hurting oil prices. Thankfully, the markets have priced a nearly 80% probability of a cut in March.

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By Alex Kimani for Oilprice.com

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Leave a comment
  • Mamdouh Salameh on January 26 2024 said:
    Oil markets are indeed underpricing geopolitical risks.

    Instead they are paying far more attention to false claims about weakening global oil demand and playing ball with deliberate market manipulations by oil traders, speculators and the United States aimed at depressing oil prices for the benefit of the stagnating US economy and the refilling of the US SPR, hence the pressure on oil prices throughout 2023.

    Dr Mamdouh G Salameh
    International Oil Economist
    Global Energy Expert

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