22 Nov 2018 18:15 IST

The crude rise and fall of oil

After the sudden and sharp fall in oil prices, all eyes are on the OPEC’s meeting on December 6

This year will be an unforgettable one for oil. The commodity price has witnessed some wild swings. The West Texas Intermediate (WTI) crude oil price surged 28 per cent from $60 per barrel at the beginning of the year to $77 in the first week of October. This strong rally kindled hopes of oil prices revisiting the $100-per barrel mark for the first time since 2014.

But the trend soon turned around — the crash in oil prices over the last few weeks has taken the market by surprise. The WTI crude oil prices plummeted 31 per cent, from $77 per barrel in early October to a low of $53 on November 20, wiping out all the gains made this year. It is currently trading at $54 per barrel.

So, why have oil prices yo-yoed so sharply this year? We take a look.

The background

Oil prices have been on a free fall since 2014. The prices tumbled from around $107 per barrel in June 2014 to a low of $29 in early 2016. As the prices recovered, a real boost came from the Organisation of the Petroleum Exporting Countries (OPEC) in November 2016. The OPEC decided to cut production for the first time since 2008. Subsequently, in November 2017, it announced that the production cut of 1.8 million barrels per day will extend up to December 2018. This was one factor that contributed to the rally in oil prices in the beginning of the year.

The economic crisis in Venezuela — one of the top oil producers — impacted oil production in the country, helping the rally in oil prices. Then there was the US imposing sanctions on Iran after pulling out from the nuclear deal in May this year. At this point, Iran was exporting about 2.7 million barrels per day, accounting for 3 per cent of the daily global oil consumption. The sanction was expected to cut the supply close to 1 million barrels per day.

These three events heightened concerns of a sharp supply disruption in the market and took oil prices higher.

The turnaround

The first hurdle for oil’s strong rally came in June. The OPEC was forced to increase supply for two main reasons. One, the pressure from the US to arrest the pace of the rally. Two, to offset the supply imbalance due to the sanctions on Iran, which came into effect from November 4. In June, the OPEC decided to increase supply. But the exact quantum of increase was not announced. The market anticipated this to be between 600,000 to 800,000 barrels per day.

Following the OPEC’s decision, WTI crude oil took a reverse, from around $75 per barrel in June to $64 in August. However, the prices bounced back as the supply disruption due to Iran sanction started to weigh on the market again. But this upward movement halted in October.

A couple of factors triggered this sharp reversal in oil prices. First, the increasing concerns of a possible fall in demand. The OPEC has been revising its global oil demand for 2019 consistently over the last few months. It revised the 2019 oil demand from 100.3 million barrels per day in June to 100.15 million barrels in October.

Secondly, earlier this month, the US temporarily exempted eight countries — India, China, Japan, Italy, Greece, South Korea, Taiwan and Turkey — from the Iran sanctions and allowed them to continue purchasing oil from it. This has eased the supply concerns.

What next?

The sudden and sharp fall in oil prices increased pressure on the OPEC to announce another production cut. All eyes are now on the organisation, which is scheduled to meet on December 6. A decision to cut production will ease pressure on oil. In such a scenario, there is a strong likelihood of the prices moving higher, back towards $65-$70 levels, in the coming months. The pace at which the prices will rise depends on the quantum of the production cut.

On the charts, the WTI crude oil (currently trading at $54 per barrel) has strong support in the $52-$50 region. This support zone is likely to halt the current fall. A strong bounce from this support zone can take oil prices higher to $60 and $65 in the coming weeks.