Geopolitical Risk, "Fear Cycle" Driving Oil Prices Higher

With the oil markets much closer to balance, geopolitical uncertainties are beginning to have a larger influence on the price of oil, something that hasn't been the case for the last 2-3 years, said by Robert Rapier at R-Squared Energy

What’s Driving Oil Prices Now

Historically, the oil industry has cycled between fear and complacency, Rapier noted. A decade ago, the peak oil narrative was the driving force behind prices. Fear and negative news pushed the price higher.

Ultimately, this dynamic ushered in the shale oil revolution and we ended up with too much oil. Supply outstripped demand, he stated, and we shifted into the cycle of complacency.

We’ve been in this cycle for around the past 3 years. Thus, any bullish news hasn’t really affected oil prices. We saw that hold true several times this year when a particularly large drawdown of oil inventories failed to move prices higher.

However, conditions are beginning to shift as we see global inventories continuing to come down and demand to grow strongly.

“Eventually we’ll get to that tipping point,” he said. “I think we are at that tipping point now where enough people realize the trends are headed in the direction of scarcity again, and that means the fear cycle could be returning.”

Geopolitics Back in Play

The world markets are beginning to remember how important Saudi Arabia is to world oil balance, and recent events revolving around the arrests of several Saudi royal family members have caught everyone’s attention.

Tensions with Iran may also lead to a reduction in supply.

“The instability in the area … makes the markets very nervous,” Rapier noted. “If we have any disruption in Saudi Arabia or Iran, we could run into a problem pretty quickly.”

Saudi Arabia is still the single most important oil-producing entity in the world, Rapier noted. One company in the country produces 10 percent of the world’s supply, and they rely very heavily on a single field.

“That’s a key concern,” he noted. “Any civil unrest within Saudi Arabia … makes the markets very nervous.”

While oil inventories are still on the high side, they are trending down, Rapier said, and markets haven’t factored in all of the geopolitical risks. If any of these risks materialize, the oil price will respond very rapidly.

Shale Oil’s Influence Waning

The shale oil revolution was unexpected, and it caught many players, including OPEC, off guard. However, OPEC still produces 40 percent of the world’s oil and its impact is relevant, especially over the long-term, though it may have temporarily lost control over the price.

When shale first came online, OPEC ended up holding production levels, helping to crash the price of oil. But there isn’t much incentive for OPEC to do this again, said Rapier.

“What would be OPEC’s motivation?” he said. “They saw what happened last time. It’s going to cost them a lot of money, and I just don’t think they’re likely to take that course of action.”

Prices are going up, and demand right now is higher than current supply, which is why inventories are coming down, Rapier noted. Unless OPEC allows members to produce as much as they want, it’s unlikely oil prices will crash next year.

Shale is one of the only reasons oil prices have stayed low in this cycle, Rapier stated. The introduction of shale supply surprised markets, and it’s one of the only things holding prices down now. Had the shale revolution not happened, we may have been looking at $200 oil today.

“If you knew when US shale production would peak and start to decline, you could be a very wealthy person,” Rapier said. “When that happens, we’re going to see oil prices (spike).”

What Happens a Decade from Now?

After the oil price collapse, many oil companies stopped exploration and capital investment. Around 10 years out from the price collapse is when the ramifications of the decisions to delay capital spending will hit.

As such, from 2020 to 2022 there will be millions of barrels of production that didn’t come online because of those capital spending decisions, he said. Depending on what demand is like in that timeframe, prices could spike higher.

“The problem is, the electric vehicle narrative is still dominating, and is still being pushed by the media,” Rapier said. “That’s not going to happen as quickly as people think.”

By 2020, it’s going to be clear that demand for oil will continue to grow. Even in places such as Norway and California, which have seen the fastest adoption of electric vehicles in the last few years, oil demand has continued to rise.

It’s happening because population continues to increase, and that trumps the increases in electric vehicles, Rapier stated. That’s going to be the case globally for many more years.

Some argue that the combination of self-driving and electric vehicles is going to push down oil consumption, but Rapier doesn’t see that happening either, at least not yet.

“There are more variables in this equation than people think,” he said. “More electric vehicles do not translate into lower oil demand. Eventually, it might, if they continue to grow at the rate they’re growing, but it’s much further out than people think.”