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Oil prices will range-trade in 2014

One, the International Energy Agency, or IEA, estimates US oil demand rose above 20 million barrels a day for the first time since the 2008 crisis.
 Two, synchronised economic growth in the US, China, Japan and Europe means global oil demand will hit a record 92 million barrels next year (the IEA estimates). 
 Three, Saudi Arabia did not play the role of swing producer and kept the 30 million Opec output cap unchanged at the recent meeting in Vienna. 
 Four, shale oil, thanks to hydraulic fracking, means at least a million barrels of Nigerian, Venezuelan and Angolan crude will no longer be exported to the US.
 Five, geopolitics in the Middle East continue to threaten energy infrastructure and chokepoints, notably the Suezmed pipeline, Suez Canal, Strait of Hormuz, Libyan, Yemeni and Iraqi oil terminals. 
 Six, the Federal Reserve did not aggressively shrink its balance sheet, even though industrial commodities fell 16 per cent in 2013 and gold has lost $500 an ounce since October 2012.

Strong demand and supply shocks were the reason Brent has remained resilient in a $105-$115 range in 2013. However, the oil market faces a major rift between Iran, Iraq and Saudi Arabia. Iran’s Oil Minister Zanganeh has refused to adhere to the Opec output cap as long as Iraqi production exceeds three million barrels a day. Iran, with its vast population and 50 per cent inflation rate, is desperate for foreign exchange.

Iran wants to replace Iraq as the Opec’s second-largest producer, a place it held under the reign of the Shah and even under the Ayatullahs. Iraq also plans to increase its production to four million barrels a day by the end of 2014, despite the lack of a Petroleum Law ratified by the Baghdad government and the de facto sovereign Kurdish enclave in Erbil.

The key to oil prices in 2014 could well be Saudi Arabia’s response to the production growth surge in Iraq and Iran. Will Saudi Arabia cut its production by a million barrels to accommodate Iran and Iraq in 2014? The kingdom pumped an extra million barrels to its current 10 million barrel level to prevent an oil spiral after Libya’s militias/tribes seized oil ports/terminals in the Gulf of Sirte after the fall of the Gaddafi regime. The US tightened sanctions on Iran oil exports after Western intelligence agencies accused President Ahmedinijad and the Revolutionary Guards of accelerating uranium enrichment in the quest for an Iranian nuclear bomb.

Why has oil not fallen $10 after the Iran deal negotiated by US Secretary of State John Kerry? The deal is interim, not permanent. US, Japanese, German and Chinese economic growth rates and industrial production are accelerating, as reflected in the strength in the diesel and distillate products markets. For now, the world oil market just does not believe the US-Iran diplomatic rapprochement will survive the fierce opposition from various sectors.

Apart from Saudi Arabia, Federal Reserve policy could impact oil prices in 2014. Strong economic data reawakened fears of a Fed Christmas tightening (tapering) and US Treasury bond yields rose to 2.85 per cent on the 10-year note while the Dow Jones index lost 300 points. If US shares and interest rates price in a Fed taper, why are crude prices so high at $110 Brent? The answer lies in the geopolitical tensions in Iraq, Nigeria, Libya, Iraqi Kurdistan, Yemen and South Sudan that have hit oil output. However, these output cuts are not permanent.

In fact, the next big event risk for oil prices in 2014 could well be Mexico’s constitutional amendment to allow foreign oil companies to invest in the deep-water Gulf of Mexico in partnership with Petroleros Mexicanos. This could well mean another million barrels in Mexican crude at a time US shale oil output could well rise to seven million barrels per day in 2014. The world’s oil exporters desperately need an output cut but Saudi Arabia refused to take out one million barrels of Arabian Light from the market.

With more non-Opec crude coming out from Kazakhstan, Canada and offshore East Africa, even Brazil and Angola, an oil glut is almost inevitable in 2014 if the Opec, with one-third of global oil output, will not lower its output cap. This means Brent could range trade in a $100-$120 range in 2014.

The writer is a Dubai-based
research analyst in energy and GCC economics.