The economy, stupid: The key factor for oil prices in 2019

The economy, stupid: The key factor for oil prices in 2019
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The global oil price took some confusing turns during the last quarter of 2018. In October, oil reached a four-year high of $86 dollar a barrel. However, by late December it had dropped 30 percent below $50 a barrel.

Prices rose for the first nine trading days of 2019, but the last few days have seen a seesaw in the oil price. What does 2019 have in store for the global oil price? Several factors affect the oil price trend.

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The most important factor that will determine the outcome of the direction is the state of the global economy. Since the direction of the global economy is uncertain, continued volatility in the global oil price can be anticipated.

There is no consensus among oil watchers about which direction the global oil price will go. The fundamentals point to two opposite trends:

On the one hand, several significant geopolitical risks point toward upcoming supply downfalls, which would boost the oil price. On the other, economic data in a number of major markets, including China, points toward recession, which would bring oil demand down. Which trend will have the upper hand?

On the supply side, two major sources of supply loss are already factored into the oil price: Venezuelan instability that will continue to bring down its oil production and U.S. sanctions that will continue to slice supplies from Iran.

However, there are potential developments that could further reduce oil supplies to the market that are not currently reflected in the price.

First,  growing protests in Iran could escalate and affect Iran’s remaining oil production. The protests have attracted little media or investor attention, so any production effect would surprise the market.

In addition, growing instability in Sudan may affect exports from Sudan and South Sudan. Sudan and South Sudan are minor producers, but loss of these supplies would affect the price trend. 

The Organization of the Petroleum Exporting Countries' (OPEC) anticipated supply cuts will also affect the oil market. The planned extent of these cuts is still undecided and may only be revealed at the next OPEC meeting in Baku, Azerbaijan on March 17. That meeting will include non-OPEC countries that coordinate on supply cuts, like Russia.

Saudi Arabia’s policy approach is the key. It seems that the depth of these cuts, and thus their impact on the price, will depend on how restrictive the U.S. is in implementing its declared sanctions on Iran.

If Saudi Arabia believes that the U.S. will be restrictive on oil import waivers and continue to apply increased pressure on Tehran, the Saudi Kingdom will comply with U.S. requests to keep pumping oil at high levels.

However, if the perception is that Washington has abandoned a strict policy against Iran, Saudi Arabia will likely support meaningful supply cuts and thus boost the oil price.  

A number of factors that are not directly connected to the oil market will also affect its price. The most important factor is the strength of the U.S. dollar. Since oil is traded globally in U.S. dollars, the strength of the dollar directly affects the oil price, with the price increasing when the dollar weakens and vice-versa.

On the demand side, the most important factor will be the state of the global economy, and this remains an unknown. Thus, volatility in the oil price will continue.

The global oil price is not only determined by the state of the global economy, but it also reflects it. If there is a sustained high or low global price, it may be a window into understanding the state of the global economy in 2019.

Brenda Shaffer is a specialist on energy and foreign policy. She is a visiting researcher and professor at Georgetown University’s Center for Eurasian, Russian and East European Studies and a senior fellow at the Atlantic Council’s Global Energy Center. She is the author of  several books, including "Partners in Need: the Strategic Relationship of Russia and Iran" and "Energy Politics."