Where are oil prices heading in 2019?

Oil prices collapsed, down by -40 per cent towards the end of 2018, emphasising the structural excess in oil supply, according to a recent report, Oil prices recovery not over yet, published by Lyxor Asset Management on February 26.

The decline in the oil price in the second half of 2018 was driven by perceptions of a weakening global economy and rising US shale oil production, according to Catherine Braganza, senior credit analyst at Insight Investment.

Ms Braganza adds: “The Opec+ Group, which consists of Opec [the oil producers' cartel] and other oil-producing countries such as Russia, reacted by agreeing in December to cut production by 1.2m barrels per day to the end of 2019.

“This appears to have underpinned prices, which trended upwards over the quarter.”

The best we can say is that if nothing changes, oil should stay somewhere between $100 and $50 a barrel.Ben Kumar

She explains: “The cuts being enacted by the Opec+ Group appear to be sufficient to remove the short-term oversupply, and if these forecasts are correct the longer-term outlook for oil markets appears more positive.”

Chris Teschmacher, multi-asset fund manager at Legal and General Investment Management, says Opec+ does not want prices too high as it encourages further global production, especially from US shale producers.

He explains: “Elevated production in the US would also threaten Opec+ market share and potentially lead to longer run oversupply in markets, eventually causing a price collapse.”

“Due to these factors, the disinflationary impact from oil prices may now be behind us," adds Ms Braganza.

If the global economy is expanding, the oil price does not tend to sharply fall – except sometimes it does, warns Ben Kumar, investment manager at Seven Investment Management.

This means, unless oil is incredibly cheap, or incredibly expensive, forecasting with any accuracy is almost impossible, he says.

Consensus forecasts are often laughably wrong, he adds.

Driven by geopolitics

Mr Kumar continues: “Growth is ok around the world, while in the collection of oil-producing nations politics rumbles along at a (relatively) normal state of unrest.

“The best we can say is that if nothing changes, oil should stay somewhere between $100 and $50 a barrel.”

But according to the report by Lyxor Asset Management, prices are not expected to revert to their 2018 highs anytime soon, bar any major geopolitical event.

It predicts Brent oil, the international crude benchmark, will creep back to a range of $65 to $70 (£50 to £54) a barrel this year.

The report also notes regular shifts in Opec versus non-Opec outputs could increase oil price volatility.

It continued: “Volatility would be magnified by a lack of visibility regarding the true supply/demand equilibrium level.

“More political noise would unsettle oil prices, reflecting divisions within Opec, the weakness of the Opec/non-Opec partnership, and intensifying tensions between the US, Saudi Arabia, and Russia.”

High geopolitical risks remain

Source: Macrobond, Lyxor Asset Management

Supply and demand dynamics

Oil prices are determined by more unpredictable variables than other commodities, and so all forecasts should be taken with a huge pinch of salt, notes James de Bunsen, portfolio manager at Janus Henderson Investors.

Mr Bunsen explains most other commodities are largely determined by basic supply and demand dynamics – prices go up if demand grows or supply looks constrained, and vice versa – but oil literally fuels the global economy, and therefore, is of huge geopolitical importance.

“No other commodity can actually precipitate a global slowdown if prices get too high,” he adds.

“When analysing where oil prices might go from here we can take a view on these overarching geopolitical issues but they are, by nature, unpredictable.”

Therefore, it is important to concentrate on supply and demand, both in the short and long-term, and acknowledge that Opec, or even US President Donald Trump, could cause prices to vary significantly from fair value in the short to medium-term before fundamentals take over again, suggests Mr Bunsen.

While Mr Kumar adds: “Supply can go up and down depending on anything from technology to politics.

“Demand is the same – billions of retail consumers, millions of businesses, thousands of utility companies around the world.”

Gregory Perdon, co-chief investment officer at Arbuthnot Latham, observes the market looks relatively balanced and therefore predicts the prices are likely to be range-bound this year.

He says: “The supply/demand dynamic features heavily in oil price fluctuation – we see supply constraints, lower interest rates, Chinese stimulus and the receding risk of a trade war all as supportive factors for oil.”

While Mr Teschmacher adds: “In the shorter term we look at global economic activity and demand to determine our oil outlook.

“Chinese growth acceleration is a high conviction view of ours… this should support oil prices through 2019.”

However, Mr de Bunsen notes one should also take a view on where the US dollar is going as a strong greenback rarely coincides with an oil price rally; although this year has been an exception.

On the demand side, he says global activity data has undoubtedly been soft in recent months.

He explains: “This has, in no small part, been due to the China-US trade spat.”

Macroeconomic uncertainties

Mr Teschmacher continues: “Signs are that both sides want a deal (China because they are suffering a proper slowdown and the US because Mr Trump has at least one eye on the 2020 election), and if resolved this should help support a recovery in the demand side of the equation.”

Peter Elston, chief investment officer at Seneca Investment Managers, reiterates that while it is always dangerous to make short-term predictions, “if the recent fall in bond yields around the world genuinely reflects weakening economic growth, there may be more scope for the oil price to fall than rise this year”.

Separately, he notes: “The secular move away from fossil fuels should also over time be expected to put downward pressure on oil prices.”

He explains: “Everyone knows that in terms of money being pumped into renewable energy, there is certainly quite a lot at present, thereby causing the demand for fossil fuels to decline.

“In the past, oil prices have gone from $150 down to $30, this may not be due to a secular trend but to some extent, it may have been.”

Nevertheless, oil price spikes continue to present a key macroeconomic risk, having preceded all but one US recessions since 1950, points out Mr Teschmacher.

He says: “It is, therefore, a commodity we watch closely because of the knock-on effects it can have for broader economic activity and asset prices.

“The oil price remains very sensitive to supply so a disruption at a major producer could send prices soaring above $100.”

However, prices as high as that are not his base case.

He continues: “Equally, a global recession would likely see prices collapse below $25, but we do not expect that for 2019.

“Our base case for oil prices is to be range bound because the major oil suppliers in the world put an effective floor and ceiling on prices.”

victoria.ticha@ft.com