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Political troubles to dictate 2016 oil markets

Supply and demand has ruled the market since mid-2014, but politics are about to take over again

Strong supply and tepid demand in recent years has allowed the fundamentals to trump politics in the oil market. Even as Islamist terrorists brutalised their way across northern Iraq in mid-2014, prices mustered a brief final hurrah. Soaring production from North America and weak consumption in China and across the OECD yielded a glut. As it became clear that Mosul’s fall would not affect Basra’s oil, the price slump got underway. 

In 2016, as the supply-demand balance tightens, politics will return to the oil market. On the supply side, Opec’s internal frictions and its dwindling spare capacity will return as themes. Unrest and war in and around oil-exporting countries, ignored by a complacent market for 18 months, will grow in significance. The pain caused by the oil-price collapse will threaten instability in some exporter countries, from Venezuela to Iraq. Sanctions, that most geopolitical of tools, are likely to start causing damage in Russia’s oil sector.

Not all of the politics in 2016 will necessarily be bullish for oil prices. Demand will also reflect political decisions about climate change, macroeconomic policy and matters such as US oil exports. Another White House race will inevitably, but unpredictably, affect global energy.

The return of Iranian energy is fraught with risks for the oil market. Its plan to add 1m barrels a day (b/d) to output next year has already fractured Opec, whose biggest members are now openly battling one another for market share. But no one knows how much more oil Iran will actually yield. The Supreme Leader’s support for the reopening is not obvious. Hardliners in the country, including Revolutionary Guards whose vested interests are now at stake, are pushing back. The reopening could be much slower than expected. 

Syria was a small oil producer before its civil war, but growing Western, Turkish, Iranian and Arab Gulf involvement – and rivalry – will unavoidably have geopolitical consequences for the region. Iraqi Kurdistan and Baghdad remain unable to resolve their arguments over oil. Iraq’s economy has been crippled by war and the plummeting oil price. Some may wonder if the country will ever be put back together. Saudi Arabia’s war in Yemen, which is going badly, and the under-reported threat posed by Islamic State (IS) within the kingdom also carry risks that have been largely ignored. A market that once used to jump at news of a bomb in non-oil-producer Israel won’t always ignore strife in the world’s biggest exporter. 

But supply-side politics could always be bearish in 2016 too. Production of Libya’s highly prized crude is struggling to stay above 400,000 b/d, a quarter of its 2011 capacity. IS’ control of the central oil crescent stands in the way of a full recovery. But a broad political agreement between the rival Tobruk and Tripoli governments would help restore output. Even without one, local deals – in the works for months – could restart big fields like Sharara and El Feel, in the southwest, pouring much more oil into the market.

Such supply gains and losses will matter more in 2016 because as non-Opec output recedes Opec’s shrinking spare capacity will come into view. In the fourth quarter of 2015 it was just 1.48m b/d, beneath even its level as oil prices surged in 2007. Almost all this spare capacity lies in Saudi Arabia. If the kingdom follows up December’s disastrous Opec meeting by raising production again, the spare capacity number will be in the red zone.

Boosters of US shale supply say this no longer matters, because any sharp price rise would bring another gushing of tight oil as wells were reactivated. But that’s an untested hypothesis. It also puts much faith in banks to extend funding back to a sector characterised by huge losses in recent months. Nor can record high OECD stocks give the same insurance as Opec’s spare capacity. At 3bn barrels, they would cover the loss of, say, Iraqi supplies for less than three months before falling back to their historical average.

To mean much to oil prices, politics doesn’t have to mean war in the Middle East or within Opec. The bearish impact of China’s politically directed economic transition is already plain. In the US, the Federal Reserve’s imminent decision to raise interest rates could be equally significant, strengthening the dollar, creating fresh headwinds in emerging markets, or even triggering recession.

Meanwhile, President Obama has already killed off the Keystone XL pipeline from Canada, a political decision that could eventually strangle some output growth in Alberta. In 2016, the US Congress might decide to lift the ban on US crude oil exports. At a stroke, it would bring the prices of WTI and Brent closer together and put some wind back into tight oil’s sails. Less predictable are the implications for US energy and foreign policy of the presidential election in November. Issues such as re-engagement or more war in the Middle East, and tighter climate rules will crop up.

Climate politics will most certainly affect the demand side of the oil market in 2016 too. The Paris meeting will partly decide this: either by its success in putting momentum behind new measures to control emissions – and, inevitably, oil consumption – or by its failure. The former could bring tighter fuel-economy standards and incentives for green energy, weakening cheap oil’s demand stimulus. Climate inaction, though, would remove some anxiety for oil producers and other polluters.

In short, the hiatus in which the economic laws of supply and demand have dominated the oil market is coming to a close. The oil depression of the 1980s ended with the first Iraq war and that of the late 1990s with the second. Shock-and-awe intervention from Opec stopped the rout of 2008. Sooner than later, politics will put paid to this latest slump too. 

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