Crude oil has fallen sharply in June, but the jury is out on whether this is just a temporary relief. Amrita Sen, oil analyst at Barclays, London, talks about the factors that drive crude oil, and politics in West Asia. Crude oil, which trades in cycles, is currently driven by the macro economic situation across the globe and slowing growth. And, till growth revives, crude oil prices will remain weak, she says in an interview with Malini Bhupta. Edited excerpts:
Brent crude has been falling since April this year. What are the factors that will drive crude oil prices over the medium term?
Crude oil trades in cycles and currently it’s driven by growth. Fundamental drivers that set the floor for crude prices are demand and supply. Economic growth is a key factor that would influence price at this point. There are many other factors like geo-political risks that influence prices too, but growth is a big component of price elasticity. Over the last few years, oil has been trading as a proxy for the macro-economic situation of the world. People short oil when economic growth weakens.
At the moment, crude has not found a floor as the sentiment on macro-economic growth remains very weak. Growth in the US, Europe and Asia, including China and India, has slowed. Unless there is a reversal in sentiment, crude oil will not see any upward move. Till last year, crude oil was driven by geo-political risk factors. Now, it’s back to macro-economic growth that is driving prices. Six months later, this might change.
Currently, is Saudi Arabia producing at full capacity? What if it agrees to cut production?
More than Saudi Arabia cutting production, demand has to pick up. In June, demand slowed down rather dramatically and that led to the sharp fall in prices of Brent. People just stopped buying in June and there is a huge pile-up of oil inventories. The expectation is that things may pick up in the second half and that may help clear some of the inventories.
After the Arab Spring that broke out last year, the breakeven for oil has touched $100/bbl, which is why oil was supposed to stay above these levels. Do you agree with this theory?
The budget breakeven that oil producing countries require is crude at $100/barrel. Whether it’s Kuwait, Iran or Libya, all them are unhappy about oil at below $100. However, Saudi Arabia has been vocal about their preference for oil at $100/barrel and they are the swing producers and have spare capacity. Even the non-Opec producers are getting to a point where they want crude oil at $100, so that they can plan capital expenditure in deep water.
So, what this means is that oil cannot go to $47-50 levels seen in 2009, post-Lehman crisis? Are the days of cheap oil over?
There seems to be a belief that oil will crash to $40 or so, but I believe that policy will not allow oil to go to those levels. It is becoming expensive to produce oil and prices will reflect that.
The bare minimum cost of production that oil companies are talking about is $75/bbl. A lot of companies are planning oil at $109/bbl. So also the fall in price will be much more measured this time. In the medium term, the world should get used to oil at $100-120 levels. Alternative sources of oil too, are not cheap. If prices continue to fall, they may cut production.
What is USA’s role in oil politics? And how will sanctions against Iran impact the demand-supply dynamics of crude oil?
As the largest consumer of oil, the US needs to keep oil at lower levels. Prior to the sanctions on Iran becoming effective from July, they had asked Saudi Arabia to increase output. However, come July 1, a lot of Iranian oil will go out of the market. That the world market stands to lose one million barrels of oil per day from Iran would definitely have an impact on prices but nobody is talking about it or the tightness it would cause in the market. Currently, this geo-political risk is not reflected in the price as oil cycles are short and currently only the macro-economic growth is driving prices.
How will things change from July once Iran’s oil goes out of the system?
Clearly, the market can tighten up quite quickly given the probability of a loss of 1 million barrels per day of crude exports. Without shipping insurance, we could also see the loss rise to 1.5 million barrels per day. That has the potential to significantly reduce OPEC crude.
Where do you see oil over the next three months?
Given how weak the sentiment is, oil will remain weak over the next three months. Sentiment takes time to turn. The fourth quarter of 2012 could see oil inch up over $100/bbl. But Brent will average at $100 in 2012.
Going forward, do you expect USA to continue to influence oil politics and consequently the price, too?
The USA consumes 80-90 million barrels of oil per day, and as the largest consumer it influences Saudi Arabia and its policies. It has strong diplomatic ties with Saudi Arabia and oil prices are defined by the relation US has with Saudi. But as growth in the US starts slowing, increasingly India and China will take on that role and influence prices. You can see this in a more pronounced way in the coming years.