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What’s driving up petrol prices: A global perspective

Soaring prices at the petrol pump are being driven by a lower New Zealand dollar and higher taxes in some regions of the country, but they are also being pushed up by global instability.

Anas Alhajji is an energy economist who has been watching and writing about the oil market and energy market, and energy geopolitics for 20 years. This interview with him is from CMC Markets’ Artful Trader podcast series.

Earlier this year, in an effort to pressure the Iranian government into changing its regime, President Trump announced his intention to reinstate a number of sanctions which were lifted under the 2015 nuclear deal. Sanctions including those on automobiles and gold trading came into effect in August, and come early November, the most significant sanctions – relating to the oil sector and central bank – will be restored.

The announcement of a halt on Iranian oil exports has disturbed the already volatile markets. Coupled with dire forecasts on the supply, demand and production of oil, it's worth asking the questions: What effect will these have on future global projections? Are we headed for a global oil crisis?

US sanctions on Iran

A comprehensive examination of trade sanctions over the last hundred years reveals that, generally speaking, they fail to achieve their objectives – and earlier Iranian oil sanctions prove a particularly interesting case study. In the past, Iran has utilised a number of smart tactics to circumvent these bans - including smuggling and selling oil under the Iraqi banner, or trading with deferred payment (given that the sanctions didn’t apply to the act of exporting itself, but rather payment for these goods).

Trump’s impending ban will apply to trades that take place within the international finance system (ie in US$), so this time around Iran has signed agreements with neighbouring countries such as Turkey, Russia and China which will enable them to trade in local currencies. They can even use gold or cryptocurrencies. There are many ways to circumvent sanctions – and the Iranians have perfected this game.

It seems the only way US sanctions would be 100 percent effective, is if the Trump administration were to deploy a complete military blockade on the Gulf – and we know this is unlikely.

While proposed repercussions are harsher than ever, will the impending US sanctions actually prevent Iran from exporting oil? And if the reality is that sanctions can and will be worked around, why have the oil markets reacted each time a sanction is announced or imposed?

Predicting market movements

Markets react to what people believe to be true – irrespective of reality. If people believe there will be a large decline in oil exports, prices will inevitably increase, until the physical market brings people back to earth, and they realise there is ample supply.

Many of those who study the oil market closely have their focus on the supply side of the equation, believing that if we lose any more from Iran, Libya or Venezuela, there’s no way to make up for that shortfall. Although such an event will increase prices, you must look at the demand as well.

Emerging markets are currently driving a significant proportion of the growth in oil demand, but factors such as a strengthening US dollar, declining government expenditures, and increasing interest rates are making the commodity increasingly unaffordable for these troubled economies. Increased oil prices as the result of a crisis in Iran would only exacerbate the problem, slowing demand significantly.

Key upcoming trends

Alongside this issue in emerging markets there are three key concerns which we can expect to see manifest over the coming years: a mismatch between oil production and demand due to shale crude quality; unsupported predictions on fuel economy trends; and increasing rates of oil consumption in Europe.

The usability of US shale oil

The IEA, OPEC, EIA, banks and oil companies have forecasted both a major increase in shale oil production in the US in coming years (which would likely flood the market), and a growth in demand for certain heavier petroleum products.

If this is proven to be the case, there could be major cause for concern - as shale is a light crude and many heavier products can’t be derived from this raw material. They cannot have both ways in these forecasts.

It’s safe to say that refiners outside the US who don’t possess the capabilities to process lighter crude as much as US refiners will not invest to expand their light crude processing capabilities if predictions show future demand lies elsewhere. This will result in a mismatch not only between oil production and refining capabilities, but also a mismatch between crude quality demand and crude quality produced.

Fuel economy

Forecasters are predicting a major decline in oil demand due to increasing fuel economy, saying that with increasing engine efficiency the use of gasoline will drop substantially. However evidence from recent years refutes this theory. Fuel economy here has nothing to do with electric vehicles.

With current technology already maxed out, (Saudi Aramco, the world’s largest oil and Gas Company, is working on a new engine technology, but it's still in the experimental stage), it will be impossible to achieve the level of efficiency needed for a notable decline in demand. Therefore, actual demand will be higher than estimated.

Europe’s oil consumption

Another, unsubstantiated, but common prediction is that Europe’s oil consumption will decline tremendously over the next 25 years. Forecasting agencies have been revising up Europe’s oil demand every quarter since 2014, but they have arguably misunderstood the relationship between GDP growth and oil demand. Also, despite Europe’s ageing population, thanks to massive levels of immigration over the last decade, we can only expect to see an increase in demand, particularly given the fact that first-generation immigrants tend to have higher than average birth rates. Europe’s future demand will likely surprise forecasters and be much higher than current estimations.

With demand increasing and the supply and quality of shale not fit to deliver, there’s no doubt that oil production at times will fall short of global demand over the next few years. With the impending sanction on Iranian oil, the most important thing to watch for through the remainder of 2018, aside from political trends, will be exchange rates.

Given the expected further strengthening of the US dollar, it looks like we’re heading towards a global energy crisis - driven by oil politics!

CMC Markets’ podcast The Artful Trader: Available now on iTunes, Android, and via https://www.cmcmarkets.com/en-nz/podcasts

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