Expect oil to bounce back – The Daily Review

My prediction model for oil prices is based on three key factors, represented graphically by arrows pointing up, down or to the side. An upward arrow is colored green and indicates an increase in oil prices. A downward arrow is colored red and points to a drop in oil prices. The side arrow is grayed out and suggests that the relevant factor is neutral with respect to oil prices.

Of course, there are innumerable sub-factors behind each of the main factors that form a cause-and-effect network and lend themselves to inferential methods. Nevertheless, the high-level "three-arrow" predictive badytic model has served us well in oil prices.

The first factor is basic supply and demand. If global economies are experiencing strong growth or supply channels are blocked or restricted in any way, this arrow will be green, indicating higher prices. Conversely, in the event of a global slowdown or a situation in which Russia, Saudi Arabia and the United States have the tap open, the arrow will be red, indicating a drop in prices.

Your correspondent inside the Great Mosque in Kuwait City. The Great Mosque is one of the largest mosques in the world. My frequent visits to the Middle East are useful for understanding the extent of Arab cooperation in oil price setting and the geopolitics of oil production in the Persian Gulf region.

The second factor is inflation / deflation, which can influence oil prices regardless of growth. It is quite possible to have inflation in recession (called "stagflation") or deflation in the growth phase.

Japan has experienced it since the 1990s and the United States has experienced disinflationary growth from 2009 to 2017. Inflation / deflation is a function of real interest rates, inflows and outflows. capital and exchange rates. Inflation is a green arrow and deflation (or strong disinflation) is red.

The third factor is geopolitics. Any credible threat of closure of the Strait of Ormuz or attack of oil production or shipping facilities will produce a green arrow indicating rising prices. Economic sanctions, a form of financial war, will also produce a green arrow.

Similarly, cooperation and peace among major oil-producing countries – or at least the absence of hostilities – will produce a gray (neutral) or red (lower) arrow for oil prices.

The geopolitical factor must be treated with care. Most badysts badume that a war between oil producing countries is automatically the cause of rising oil prices. This is only true if oil facilities are directly targeted. A war between oil suppliers results higher production, not inferior, because the warring powers are desperate to make money to fight.

The best example is the Iran-Iraq war of 1980-1988. From 1 September 1983 to 1 February On 1 January 1986, at the height of the war, oil prices plunged 67 per cent from $ 30 per barrel to $ 10, while Iraq was furiously pumping oil to earn a hard currency and support their war efforts. Oil prices rise when the war is threatened, but tend to fall once the war has started.

Predicting oil prices using this model is particularly difficult when factors send out conflicting signals. For example, the current model shows that global growth is slowing down, putting downward pressure on prices. But Russia and Saudi Arabia, two of the world's "three largest" oil producers (with the United States), plan to cut production, and Saudi Arabia is cutting back on oil shipments to the United States.

These tactics drive up the price of oil. Inflation / deflation indicators and geopolitical parameters also emit mixed signals.

Oil and gold are two commodities that can rightly be considered money or money substitutes in the global money markets. With this complex data landscape, what are the prospects for oil prices in the coming months?

The most important factor in petroleum badysis is the supply / demand factor.

Global growth is slowing, suggesting a drop in oil prices. In an extreme case, a global recession or a financial panic would lead to lower prices. But the slowdown in growth is not yet at this stage. Even if the demand for oil flattens, Saudi Arabia alone can increase the price simply by reducing its production.

This is what happens.

Saudi Arabia has cut back on oil exports to the United States, forcing the United States to use more of its own oil and cutting US inventories, closely followed by badysts and traders. As a result, oil prices rise, while supply in the United States declines.

This maneuver from Saudi Arabia is partly a response to a tactic used by Trump earlier this year. Trump wanted oil prices to fall before the US elections. He also threatened severe sanctions on Iranian oil exports.

Saudi Arabia helped the United States by increasing oil production to offset Iran's potential deficits and help moderate price increases before the US intervened. The result was a serious drop in oil prices visible in Chart 1 below:

Chart 1 – Oil prices in dollars per barrel (right scale):

Trump took advantage of lower oil prices, but did not resist the conclusion of his contract with Iran. The Trump administration has granted sanctions relief to all major oil customers in Iran, including India, China and Japan. The United States had low oil prices and Iran was relieved of sanctions.

Saudi Arabia is the only loser. The fall in prices was the cause. It is now time for Saudi Arabia to balance itself by reducing supply and raising prices.

The inflation / deflation factor is neutral at the moment. Central banks certainly fear inflation for an badysis of the imperfect Phillips curve, but evidence of real inflation is almost non-existent. A disinflationary trend is equally likely if one relies on an excessive tightening of monetary policy through a combined policy of rising rates and spending restraint, called "quantitative tightening."

The geopolitical factor is also neutral. An important geopolitical hardening could be envisaged if the sanctions imposed on Iran were tightened in 2019 and 2020. A geopolitical shock in the Persian Gulf could bring it down to 100 dollars. Trump having given up the Iranian nuclear deal this spring, this possibility remains.

But for the moment, the situation is tense but calm.

With geopolitics and inflation / deflation both blocked and the supply / demand factor indicating rising prices as the Saudis reduce supply, the net of the "three arrows" is the rise in oil prices. in the near future. Rising inflation in dollars could also lead to higher prices.

Any evidence of actual inflation or sudden increase in tensions with Iran could lead to an upward upward trend.

Regards,

Jim Rickards
for theDaily report