Oil market risk factors | FinReview
29 January 2021

Oil market risk factors

2021 started positively for the oil market – oil rose in price after the next OPEC+ meeting, but the risks of destabilization are still high, since the higher the prices, the more negative factors. Analysts at FinReview.info talked about what could negatively affect oil prices in 2021.

In early January, OPEC+ held another meeting, which resulted in an increase in oil production by 75 thousand barrels per day in Kazakhstan and Russia for domestic consumption. Against this background, Saudi Arabia decides to voluntarily cut its own productivity by 1 million barrels in February and March above the current quota. This decision became the driver of the growth in oil prices through the barrel. Considering additional reductions in Saudi Arabia, the total reduction in February will amount to 8.1 million barrels per day.

For OPEC members, there are no changes for February in individual quotas. All productivity gains go to non-OPEC countries: Kazakhstan and Russia. According to official figures, the increase in productivity was made against the backdrop of an increase in domestic consumption in the winter. However, the fact that non-OPEC countries were the only ones allowed to increase their share within two months could indirectly weaken OPEC’s weakening in the market as a single player.

Brent crude prices traded in a wide range from a high of $64 per barrel of Brent at the beginning of the year to a low of $18 in April 2020, the lowest average price in real terms since February 1999. The main reason of the fall in oil prices is limiting the decline in oil consumption due to the widespread austerity measures and sharp factors of growth in world reserves, but the secondary factors are the misuse of OPEC+ to negotiate in a short time and political reasons. As can be seen from the graph below the decline in oil production, a consistent delay in relation to consumption of financial indicators between oil-producing countries, suppliers of which are investing negative expectations for oil.

However, during the remainder of 2020, oil prices rose on the back of a relaxation of restrictive measures, economic recovery, higher oil consumption and a reduction in production to a drop in global reserves. In September and October, the price began to fall again due to negative sentiments regarding the second wave of the pandemic. However, by December, oil prices rose to a monthly average of $50 a barrel of Brent, in part on expectations of an economic recovery and persistent news of the success of multiple COVID-19 vaccines. Brent crude oil prices reached $55 per barrel in early January, the highest level in 10 months.

Many factors are involved in the formation of the level of oil prices, which determines their volatility. In the analysis, you can select the following groups of factors: fundamental, speculative, and geopolitical.

The fundamental factors are oil production and consumption, economic development and growth, accumulated reserves. The ratio of production and consumption shows whether the balance is observed. It is important that demand does not exceed supply, since this is a negative signal that drives oil prices down, as it was in April 2020. Consideration should be given to the oil reserves indicator as it can imbalance the production-to-production ratio. Economic development and growth are the key factor driving the growth of consumption, due to which the faster its production grows and the greater the volume of oil consumption. The reduction of oil production quotas under the OPEC+ cartel agreement is only a temporary measure balancing production and consumption. The main factor behind the rise in oil prices in 2021 will be the economic recovery.

In addition, it also influences the factors of the stock market, which in general can be designated as speculative factors, since they depend on the mood of investors. The general positive and factors influencing the stock factors of the growth of oil prices, exactly, as well as vice versa. This is evidenced by the relationship between the MSCI index (global index) and the price of Brent crude oil. Also significant is the number of open short and long positions for Brent & WTI crude oil, which indirectly signal the expectations and sentiments of agents.

Geopolitical factors are the most unpredictable force that can move prices up or down. For exitance, oil rose in price from $16.5 in July to $32.9 a barrel in October 1990 following Iraq’s invasion of Kuwait, as oil production fell sharply, and Iraqi oil exports were banned. Now the relationship between OPEC+ members and non-members leaves many questions: like in April 2020, when the countries could not agree on quotas for a long time due to the political background of the issue of American shale oil and the absence of mechanisms for regulating production in the states. On the one hand, we see the growing influence of Russia among the oil-producing countries and the decrease in the influence of OPEC, and on the other hand, the threat in the form of shale oil, which can serve as a destabilizing factor.

Average prices for Brent crude in 2020 were at $42 per barrel, so the baseline scenario for 2021 is average annual Brent prices of $50-45 per barrel. This price level reflects a 6% increase in global oil consumption over 2020 levels (97.8 million barrels per day) and projected global GDP growth of 5.6% and 4.3%, 4.6% and 8.4%, respectively, in the US, Europe and China. next year. This prognosis depends on the rate of vaccination of the population and changes in consumer behavior after it.

Vaccination of the population started together with 2021 and can take from six months to a year, considering the time to produce consumables, supplies and vaccinations. Since oil prices are based on expectations to some extent, if the economy does not show a quick recovery, then oil prices may be corrected by 5-10%.

High risks are associated with the degree of reaction of the US shale industry to the rise in oil prices in the last 3 months from $36-40 per barrel to values above $50 per barrel in recent days. The profitability of shale oil companies, according to the latest data, can vary from $46 to $52 depending on the field, so it is obvious that if Brent prices start to rise and reach stable levels of $55-60, the number of shale oil drilling rigs will also start to grow.

Shale oil production could hinder the efforts of OPEC+ to support the market, thanks to which prices return to pre-crisis levels. The production outlook for 2021 is now slightly more optimistic for U.S. shale as oil prices rise and production is expected to recover in the second half of 2021.

The rapid increase in the supply of unconventional oil in the recent past has created problems for OPEC. The growth in shale production, spurred by OPEC supply cuts to maintain prices, contributed to a glut during 2014-16. This glut eventually led to the creation of OPEC+, which began to limit production even further in 2017.

The recovery in the US shale industry will undoubtedly pose major risks to price stability. If during the year prices add up at the level of $ 55 to $ 65 per barrel, then the return and activation of the US shale industry is possible, which can pull prices to the levels of $ 40- $ 45 and even $ 35 per barrel, with an increase in shale production by 200-500 thousand barrels per day or more. Nevertheless, Kazakhstan is ready for similar scenarios, since in the budget for 2021-2023 the price per barrel of oil is set at $ 35.