A perspective from E*TRADE Securities2
With summer behind us and the holidays ahead, history tells us that crude oil prices should be taking a breather right about now. That appears to be happening, but whether it will last is anybody’s guess—particularly given potential supply disruptions from hurricane season and escalating trade tensions.
Why should you care? Well, oil can have a ripple effect on more than a few sectors and asset classes. While rising energy prices can put a damper on consumer spending, the same trend can boost energy stocks. In the developing world, high energy prices can help or hinder emerging market shares, depending on whether or not a country is a net energy exporter.
Oil prices peaked early this year: What gives?
As we’ve seen consistently throughout history, oil prices are largely a function of supply. The oil shocks of the 1970s were one of the most visible examples. From the production quotas set by the Organization of Petroleum Exporting Countries (OPEC) to the boom in North American Bakken shale production, supply considerations wield considerable influence over oil prices.
However, when we consider the seasonality of oil, it’s impossible to ignore demand. As you can see in the chart below based on 35- and 15-year averages, oil prices tend to rise through the summer months before peaking in the late summer or early autumn as summer driving season winds down.
Source: Moore Research Center, Inc.
Source: FactSet Research Systems
Tariff concerns and the link to oil prices
One of the reasons for recent weakness in oil prices may very well be—and stop us if you’ve heard this one before—tariffs. As we’ve pointed out before, tariffs have historically impeded economic growth, not helped it. Many analysts believe US-led trade restrictions could weaken global growth rates, which could, in turn, reduce aggregate demand for oil.
This week, President Trump announced a new round of tariffs on Chinese imports to the tune of $200 billion.1 This comes on top of the $50 billion in tariffs already imposed on Chinese goods. Not surprisingly, equities retreated on Monday, as they have all year following tariff warnings, while crude oil futures also fell.
As is usually the case, however, supply considerations also loom large.
Sanctions on Iran could push oil futures higher
China isn’t the only country the Trump administration is warring with economically. The administration has pulled out of the Iran nuclear accord, which was brokered by the Obama administration and agreed upon by seven world powers. In addition, the US has placed new sanctions on Iran that go into effect in November. As part of this move, the Trump administration has indicated that the US could impose sanctions on other countries that purchase oil from Iran.
America’s trading partners are apparently taking the threats seriously.
Iranian crude oil exports have declined by 580,000 barrels per day over the past three months, and many analysts believe this is just the start.2 In fact, some analysts predict that oil prices could surpass $90 per barrel in 2019, owing directly to US sanctions on Iran.3
India, Iran’s second-largest oil customer, is an interesting case study. Although Indian officials have refused to recognize US sanctions on Iran, it’s still in India’s best interest to curry favor with Uncle Sam in order to maintain exposure to the US financial system. As a result, India has cut its crude imports from Iran by nearly half so far this year.4 Collectively, individual decisions like this have put pressure on Tehran to cut supply, which could help put a floor on oil prices.
Takeaways for investors
Given the sometimes counteracting forces of supply and demand and a backdrop of near-weekly trade salvos, it’s difficult to say where oil prices are headed. Nonetheless, there are lessons investors can learn from this period of uncertainty.
• Keep an eye on tariffs. If the continuous volley of trade threats slows down, oil prices could move higher. Bear in mind that oil prices are largely a reflection of expectations for supply and demand. Easing trade tensions would ostensibly bode well for global economic growth, which could support crude oil futures.
• Watch for economic growth numbers. The US economy is humming on all cylinders, but warning signs abound. While no one wants to see a slowdown in economic growth, one upshot of moderating economic numbers could be lower oil prices.
• Stay diversified. Even if you’re bullish on energy futures, making a big play on energy could backfire if trade wars continue to dominate the headlines. Any allocation in energy stocks should be part of a diversified portfolio that includes a broad range of equities and fixed income holdings.
When it comes to energy prices, the expectations of futures traders are just as relevant as what’s actually happening in oil fields and refineries across the globe. How these speculators interpret the headlines we see daily could inform what you pay at the pump this holiday season.
1. Bloomberg, “China Strikes $60 Billion of U.S. Goods in Growing Trade War,” September 17, 2018. https://www.bloomberg.com/news/articles/2018-09-17/trump-ratchets-up-tariff-pressure-on-china-with-200-billion-hit
2. Reuters, “Oil near flat as market weighs U.S.-China trade tensions, Iran sanctions,” September 16, 2018. https://www.reuters.com/article/us-global-oil/oil-higher-as-us-sanctions-on-iran-raise-supply-concerns-idUSKCN1LX01V
3. Bloomberg, “Oil at $100 Is a Possibility Next Year, Bank of America Says,” May 10, 2018. https://www.bloomberg.com/news/articles/2018-05-10/oil-at-100-is-a-possibility-next-year-bank-of-america-says
4. Reuters, “India's Iran oil purchases to fade ahead of U.S. sanctions,” September 16, 2018. https://uk.reuters.com/article/india-iran-oil/rpt-exclusive-indias-iran-oil-purchases-to-fade-ahead-of-us-sanctions-idUKL3N1W042S