How High Can Oil Prices Rise

The question of how high oil prices can rise depends on three factors. One, the effect of sanctions on Iran’s crude oil exports. Two, the extent to which OPEC and NOPEC members are willing to increase production levels to counter the expected downfall in supply. And, third, the gravity of trade war. Both the countries have to stop as doing otherwise might threaten a global recession or serious distortions in international trade. However, neither Trump nor China have hinted of any reconciliation soon.

As I explained in an article last month, the two main driving forces for oil remains the Iranian sanctions and trade war. Think of both the factors as an ends of a continuum and oil prices, at least till 4th of November, is bound to oscillate in this very continuum. $85 bbl. and $75 bbl. for Brent and WTI respectively seems a psychological ceiling, albeit prices have struggled hard to break the $80 (and $71 barrier) and sustain such gains.

According to recent data by S&P Global Platts, Iran’s oil and condensate exports increased for the period of 1st September to 15th September to 1.69 million bpd from 1.48 million bpd from 1st August to 15th August. It is instructive to note here that China and India account for almost 50% of Iran’s oil exports. Both have resisted halting oil imports from Iran. According to Platts, Indian oil trades with Iran, albeit declining last month, are expected to recover later this month. It is also working to win some waivers as US last month showed a willingness to consider waivers on a case by case basis. China has categorically refused to stop buying oil from Iran. China imported almost double the amount of oil from Iran in September as compared to August, 813,333 bpd and 466,333 bpd, respectively.

Even if the figures are not promising and clearly show a decline of total Iran’s exports, it is safe to conclude that the full effect of sanctions is yet to be realized.

The second factor which is closely related to the above point is the issue of other producers, OPEC and NOPEC, increasing production to offset the effect. The OPEC Joint Ministerial Monitoring Committee held in Algiers on Sunday was very important in this regard. Albeit the JMMC has not agreed on any immediate production increase they have signaled that the group needs to bring the compliance rate back to 100 percent, which means they will boost production in the coming months. How they are going to do that isn’t clear, Kuwait-Saudi Arabia is the only producers in the group with that spare capacity. In their November 11th meeting, we shouldn’t be surprised with the group decides to step in to compensate for the lost barrels.

All will depend on the extent of loss from Iranian sanctions. We should also take into account the fact that higher oil prices also affect the future demand in consumer countries like China. Hence, there has to be a natural ceiling for prices to peak.

The third factor that further weighs down on oil prices is the on-going trade war between the US and China. Recall that there were trade talks last month that ended without any positive result. Now as the Trump administration has imposed another round of tariffs, this time totaling a whopping $200 bn, with a tranche of $267 bn further in line, the future looks uncertain.

Recently US Treasury Secretary Steve Mnuchin offered China for another trade talk but the talks were cancelled. It was expected from the starting. Now, as China has retaliated with $60 bn of counter-tariffs, the situation is heating up to the point of no return. China is now considering other ways, such as tweaking with the supply chain and imposing special tariffs on the most imported goods from US. Therefore, the effect of trade war shouldn’t be underestimated as it can threaten the current international rule based trade order.

To return to our question of how high can the oil prices rise, we must consider the interplay of all the factors described above. Then, we might reach the conclusion that current price rally might be a tad over-hyped. Traders have already discounted into the price of crude the effect of sanctions on Iran. Therefore, we shouldn’t be surprised if we see a correction as we near the November 4th deadline.

What’s in it for investors?

A good strategy is to short oil in the coming days. But now the question: When should we short it? Last week oil broke the resistance of $80 for the first time since May’18 and WTI touched $71.22. Oil prices then dropped back to the $68-$69 range. The reason for this sudden hike was Tropical Storm “Florence” which wreaked havoc in the Southeast US this month. The hurricane season along with dwindling inventories, therefore has pushed oil prices even higher. But trade war remains a bearish factor weighing down on prices. Therefore, I’d suggest that any price between $68.90 to $72.50 for WTI (CL1) and near $82 for Brent (BZ) is a best bet for short selling, with a $2 profit target in mind. In October, Trump may also proceed with Strategic Petroleum Reserves’ (SPR) release which might give another opportunity to earn from an expected dip – which might come before, as traders weigh in prospects. ETFs like USO and BNO are good options.

Bottom line for investors – To short sell oil as it reaches the levels described above is a safer bet than to go long right now. The prices have already discounted in much bullishness.

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