Trump to have little impact on oil prices despite his efforts

Trump to have little impact on oil prices despite his efforts
© Getty Images

Oil prices fell Friday as President TrumpDonald John TrumpStates slashed 4,400 environmental agency jobs in past decade: study Biden hammers Trump over video of world leaders mocking him Iran building hidden arsenal of short-range ballistic missiles in Iraq: report MORE tweeted that “…with record amounts of Oil all over the place, including the fully loaded ships at sea, Oil prices are artificially Very High! No good and will not be accepted!”.

Unfortunately the tweet was not entirely accurate, floating storage has shrunk dramatically over the last two years, and crude inventories in the Organization for Economic Cooperation and Development (OECD) have fallen sharply.

Indeed, one reason for the rally in prices since the middle of last year is the fact that stocks have dropped by so much.

ADVERTISEMENT

Admittedly, oil prices would be lower if the Organization of Petroleum Exporting Countries (OPEC) and its allies increased output. Recall that the cartel, along with Russia and some smaller producers, cut output by about 1.8 million barrels per day (bpd) at the beginning of 2017.

 

This represented a reduction in global oil production of about 2 percent. But lower oil prices could also mean less production in the U.S., which would offset some of the increase in OPEC production.

At face value, it appears that there is not much Trump can do about high oil prices. After all, unlike most OPEC countries and Russia, where oil production is controlled, either directly or indirectly, by the state, the U.S. president has very little influence over how much crude the U.S. produces.

That said, if President Trump really does want to lower oil prices, there are a number of actions he could take.

First, a key driver of the recent rally in prices has been the risk that the U.S. will re-impose sanctions on Iran’s oil exports next month. The previous round of sanctions reduced Iran’s oil output by about 1 million bpd.

If President Trump makes it clear that he is not intending to tear up the nuclear deal with Iran, we would expect oil prices to drop sharply. However, this does not seem particularly likely.

Trump has been a critic of the deal since before he was elected and is surely well aware that threatening to re-impose sanctions on Iran would drive up oil prices.

Second, Trump could release some oil from the Strategic Petroleum Reserves (SPR). Indeed, Trump has already mooted selling off half of the SPR to help plug the budget deficit, and the U.S. is already planning major sales from the SPR over the next few years to pay for maintenance to the facilities.

The SPR currently contains about 665 million barrels of oil, enough to cover about 100 days of net imports, up from around 90 days in January 2017. This means that, assuming net imports remain steady, Trump could release 1 million bpd from the SPR for about two months without dipping below 90 days net imports cover.

This would put significant downward pressure on oil prices for a while. But prices would rise again once sales stopped and a release from the SPR would effectively be competing with U.S. producers, which Trump is unlikely to want to do.

Third, speculation that OPEC will keep restraining production well into 2019 has boosted oil prices over the past month. Trump could put pressure on Saudi Arabia and its other allies in OPEC to publically commit to ending the output cuts deal at the end of the year or sooner, although given Saudi Arabia’s commitment to the deal, it is unlikely that they would be willing to do this.

Admittedly, the rise in fuel costs will eventually weigh on the disposable income of consumers and the profits of non-oil businesses. Indeed, despite the surge in U.S. oil production over the last year, the U.S. is still a significant net importer.

As a result, the U.S. economy would, on balance, benefit from lower oil prices. However, higher oil prices have caused an immediate surge in mining investment, as more drilling rigs have been deployed, and those firms associated with oil production have seen revenue boom. This has contributed to the strong economic performance in the U.S. over the past two years.

The upshot is that we doubt Trump will take any action to reduce oil prices. Instead, we expect prices to fall back from current levels as higher oil prices encourage significant additional non-OPEC production, especially in the U.S., where drilling rig numbers are very responsive to prices.

What’s more, we expect OPEC to gradually increase output next year.

Thomas Pugh is a commodities analyst for Capital Economics, an economic research consultancy based in London.