The Fuse

Oil Markets On Edge Over Trump-Xi Meeting

by Nick Cunningham | June 19, 2019

The jolt to oil prices following the attack on two tankers in the Gulf of Oman last week quickly wore off, as oil traders immediately shifted their sights back onto flagging oil demand and cracks in the global economy.

Barring a severe supply outage, it may take a trade breakthrough between the U.S. and China to rescue oil prices.

The cycle of escalatory measures between U.S. and Iran has continued in recent days, leading to a ratcheting up of pressure and putting both nations on the brink of a military conflict. However, oil markets remain muted. Barring a severe supply outage, it may take a trade breakthrough between the U.S. and China to rescue oil prices.

Demand weakens
The U.S. government blamed Iran for the attacks in the Gulf of Oman, and the Trump administration has decided to send 1,000 additional troops the region. Iran, for its part, said that it would breach uranium enrichment limits in short order, after being denied the benefits of the nuclear deal. The two countries seem trapped in a cycle of escalation, with no obvious way to diffuse tensions. The conflict puts the Strait of Hormuz in the spotlight, through which nearly a third of global seaborne crude oil is traded.

Despite all of this, oil prices have barely budged. More storm clouds are forming over the global economy, raising fears of a recession. Weakening demand has become the overarching concern for the oil markets, topping even a potential conflict in the Persian Gulf, a once unthinkable dynamic. “The oil market seems fixated on demand-side risk, and is not pricing in supply-side risk no matter how elevated it might be,” Standard Chartered wrote in a note.

“True, total OECD oil inventories remain balanced for the time being and Iran tensions have not gone away, but we now see a weakening demand backdrop,” Bank of America Merrill Lynch analysts wrote in a report to clients. “As demand falters, oil prices will have to adjust lower to slow down the pace of US shale supply growth.”

Several energy analysts issued multiple downward revisions in their oil demand forecasts, noting the deterioration in economic growth. The U.S. EIA lowered its demand estimate for 2019 to 1.2 million barrels per day (Mb/d), a downward revision of almost 200,000 barrels per day. In dueling Oil Market Reports, OPEC and the IEA followed that up with their own revisions, lowering demand figures for the year by 0.07 Mb/d and by 0.1 Mb/d, respectively.

“The consequences for oil demand are becoming apparent. In 1Q19, growth was only 0.3 mb/d versus a very strong 1Q18, the lowest for any quarter since 4Q11,” the IEA said on June 14.

The numbers vary depending on the forecaster, but ultimately global demand may grow at its slowest pace in years.

Some top investment banks are even more downbeat. JPMorgan Chase says demand may only grow by 800,000 barrels per day this year. The numbers vary depending on the forecaster, but ultimately global demand may grow at its slowest pace in years.

Trade war dominates oil market narrative
A string of data releases point to an economic slowdown. Weaker manufacturing activity (as measured in PMIs) has been seen in the U.S., China and Europe. Weaker petrochemical demand is visible in Europe, while the U.S. has seen softer-than-expected gasoline and diesel consumption. The “common theme across all regions” is the U.S.-China trade war, the IEA said, which looms large in just about all of the gloomier forecasts as of late. The IEA added that oil demand should rebound later this year, but only if the “trade disputes are resolved and confidence rebuilds.”

Indeed, the only signs of life that crude oil prices have exhibited lately came on June 18. President Trump tweeted that he and Xi Jinping were set to hold an “extended meeting” on the sidelines of the G-20 Conference next week in Japan. Oil prices surged on the news.

Given the tepid response from oil prices amidst the escalating U.S.-Iran tension, the spike in prices on the mere hopes of a trade breakthrough indicate how fixated oil traders have become on waning oil demand and the odds of economic recession.

Heading into the meeting, both the U.S. and China are staring down a dramatic deceleration in economic growth, which presents domestic political threats to both leaders. On the other hand, being seen as backing down in the face of withering pressure from a top adversary would also be politically damaging to either or both sides. The stakes are high. A breakthrough in negotiations could lead to an easing of tariffs, providing a positive jolt to the global economy. However, an impasse would not only keep the current tariff regime in place, but President Trump has vowed to hike tariffs on another $300 billion of Chinese imports, which would drag down demand further.

“Either manufacturing sentiment improves on the back of a new US-China trade deal in the next three months, or trade tensions risk driving the global economy into a deeper and more prolonged slowdown”

As such, the Trump-Xi summit is somewhat setup to produce a binary outcome. “Either manufacturing sentiment improves on the back of a new US-China trade deal in the next three months, or trade tensions risk driving the global economy into a deeper and more prolonged slowdown,” Bank of America said.

“Our global demand growth projections of 0.93mn b/d and 1.00 mn b/d for 2019 and 2020 are roughly aligned with our economists’ GDP forecasts. Yet there is a risk we end up being too optimistic if the US-China trade relationship deteriorates further,” the investment bank said. “Additional tariffs would likely force us to revise our numbers lower.”

OPEC+ plans on meeting to discuss the production cuts in Vienna in the next few weeks. With just about all major forecasters predicting global oil production growth to outpace demand this year, the group may have no other choice but to keep the supply curbs in place for a longer period of time. Notably, however, OPEC+ has delayed its scheduled meeting so that it can take place after the Trump-Xi meeting, an indication of how important the outcome of those talks are on the global oil market.

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