On July 22, 2019, Iran announced the arrest of 17 Iranian citizens on charges of spying for the US, a claim that President Donald Trump dismissed as “totally false.” This came just after Iran seized a British oil tanker in the Persian Gulf. These events culminate weeks of growing tension between Iran and the US.
In the past, the price of oil would have skyrocketed on such clear and present dangers. Yet the price of oil has hovered between about $55 to about $65 per barrel during the entire period. Yet the S&P 500 has gradually moved higher throughout the entire time, without missing a beat.
How is this possible? “We have moved into a demand-led market, away from a producer-led market,” comments Nick Butler, chair of the Policy Institute at King’s College London.
“OPEC’s glory days are over. The world’s call on the cartel’s oil is down to levels not seen since the early 1980s,” he adds.
Demand is weak and OPEC cuts won’t matter
The weakening global economy just isn’t supporting sufficient demand for oil, Butler continues.
“Over the past five years, the market’s move from being producer-led to a situation where the risks to prices, even after they have fallen from $110 a barrel in the early months of 2014 to around $60 now, are still predominantly on the downside,” Butler explains.
In the past, there would still have been market reaction to the loss of production from Venezuela, Libya and Iran. But traders have simply paid no attention.
Nor are the projected OPEC production cuts likely to change the overall lack of concern. These are planned to take 1.2 million barrels per day off the market. But the price of oil has not risen in response to the announcement.
“OPEC production adjustments have historically not been able to match the velocity of demand declines during recessions, leading to rising inventories, contangoes and lower prices,” industry analysts at investment bank Goldman Sachs write.
US Shale boosts confidence in increasing supply
From the point of view of investors, it is not so much the momentary status of demand, but rather the assuredness of continually increasing supply that has taken the price of oil off the list of game-changing factors.
US American shale production has gone from practically nothing as little as 10 years ago to 16.6 million barrels per day, and with further increases predicted over the next five years. This has occurred despite the fact that many US shale oil producers are not making a profit, due to the low price of oil. So, as far as many economists are concerned, higher oil prices are only good for the US economy, and ultimately for the rest of the world, as sufficient supply is a powerful force for economic stability.
Markets follow where oil leads
Surprisingly, as the markets cease to see the price of oil as having much affect on stock prices, they do continue to follow it as an indicator of economic strength or weakness.
Stocks have become far less of a lead indicator and more of a concurrent indicator than they have been,” says Julian Emanuel, head of equities and derivatives strategy at BTIG. We look to the price of oil to see when a recession is coming, or if growth is in store, he adds.
Russia’s power grab contained
Russia is also losing revenue because of the low price of oil, and oil and gas sales are responsible for more than 60 per cent of Russia’s exports and provide more than 30 per cent of the country’s gross domestic product.
Yet Russian President Vladimir Putin apparently isn’t worried. He claims that $40 per barrel is more than enough for the state budget, and at that price, Moscow can replenish its gold and forex reserves.
“Russia doesn’t need oil prices to be too high and sees a price of $60-$65 per barrel as quite satisfactory,” Putin said at a recent press conference.
“The Russian processing industry itself is not interested in very high oil prices. Well, the average price around $60-$65 per barrel is quite satisfactory, we don’t need to drive up the price to the top, we already have a decent margin, in terms of budget.”
Yet Russia agreed to the recent OPEC production cuts without much discussion. Putin needs the revenue to finance his ever-increasing defence demands: Russian military spending fell to about $64 billion in 2018, according to the Stockholm International Peace Research Institute. According to the Institute, Russia needs close to $10 billion for its nuclear programme alone, and that figure is considered a low estimate.
Conclusion: A shift in geopolitics and economic power
It’s a bit early to write off oil producers as an economic power. At the same time, the ability for OPEC to destabilise the West with control of oil, as it did in the 1970s, is no longer a threat. And thus the markets keep their eye more on high-tech, and less on commodities.