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Economics, not geopolitics, will define oil prices in 2024

War in Ukraine and Gaza and missile attacks in the Red Sea are unlikely to have an effect

Israeli soldiers in Gaza Reuters
An escalation of the Israel-Hamas conflict would dampen the growth outlook for the GCC's economies but has not increased oil prices

If there was one dominant theme in the global oil and gas market in 2023, it was that the economics of supply and demand, combined with macro hedge fund positioning, trumped recurrent geopolitical stress in the Middle East. The same is likely to be true for oil prices in 2024.

To be sure, the onset of the Israel-Hamas war on October 7 led to an initial spike in the geopolitical risk premium, and Brent crude dutifully surged to $95 a barrel.

Then last month a tsunami of hedge fund short-selling took down prices by 25 percent to $74.

Next, Houthi rebels in Yemen fired salvos of missiles and drones at Israel-linked vessels and have disrupted tanker and container shipping routes in the Red Sea.

A US-led multinational task force has been deployed to the Middle East’s third-biggest energy choke point after the Straits of Hormuz and the Suez Canal.

Yet this escalation in naval tensions has had only a muted impact on the geopolitical risk premium in oil prices.

Brent rose from its $74 December low to only $79 at the end of the month, despite a White House statement that implicitly threatens the destruction of the Houthi launch sites via the US Navy’s arsenal of carrier-based Tomahawk cruise missiles and F-18 warplanes. 

While it may be expected that the Gaza war would have little or no impact on tanker traffic in the Gulf, even the current escalation in the Red Sea is not sufficient to warrant a sustained rise in the world’s pre-eminent light, sweet crude benchmark.

Why? A surge in US oil production to 13.3 million barrels per day (bpd) at a time of falling diesel demand in China and an industrial recession in Europe has led to a supply glut in the global market for oil, natural gas, liquefied natural gas (LNG) and liquid fuels.

The spectacular success of American drillers in Texas’s Permian Basin and North Dakota’s Bakken oil fields, as well as in the Gulf of Mexico, has enabled the US to produce more oil than any other nation in history.

The US now exports 6 million bpd, and American LNG tankers have easily replaced those Qatari gas tanker cargoes disrupted by the Houthi missiles launchers in the Red Sea.

The global oil futures, options, swaps and spot tanker cargo markets have obviously concluded that not even the threat of violence between a multinational naval task force and Houthi rebels can offset the current supply glut and bloated stockpiles in the US – which has replaced Saudi Arabia and Russia as the planet’s new energy superpower – and send oil prices higher in 2024.

The geopolitical traumas of Ukraine, Gaza and Yemen did not change the cold calculus of supply and demand in 2023.

This theme will dominate sentiment, positioning and capital flows and prices in the year to come in the “paper oil” exchanges, whose daily trading volumes are 20 times more than the 100 million bpd+ of oil consumed.

Brent crude now trades 18 percent below its September peak for one major reason.

The 4,000-odd US shale oil and gas drillers respond only to Adam Smith’s invisible hand – the price of oil in the global market, not the diktat of the energy secretary in Washington DC or the Opec+ secretariat in Vienna.

Shale oil expansion

Stung by the oil crash of 2020, American shale oil drillers opted for capital discipline and repaid expensive debt to their bank and high-yield bond underwriting syndicates on Wall Street, rather than expand production.

As global economic activity resumed, the Saudi Arabia-led Opec+ has tried to nudge the price of oil higher via successive output cuts, a process that was amplified by Russia’s invasion of Ukraine in February 2022.

Brent surged to $130 a barrel and it was entirely rational for American shale oil drillers to expand output dramatically, since the technology of horizontal drilling and fracking means that their break-even cost of production has fallen as low as $32 a barrel.

This windfall for shale oil drillers could not last. The Biden White House has successively released billions of barrels from the Strategic Petroleum Reserve and has allowed ostensibly sanctioned Iran to increase its output to 3.2 million bpd.

Nonetheless, the invisible hand that governs Wall Street decreed that the surge in US output would derail Saudi Arabia and Opec+’s periodic output cuts.

So Saudi oil production has fallen to 9 million bpd, at least 3 million bpd below its spare capacity level. Yet Riyadh’s successive output cuts have coincided with a sharp fall in Brent crude.

The year ahead will witness new output increases in the US, Brazil, Guyana and Venezuela, at a time when the IMF has slashed its global growth forecast to 1.5 percent, a level seen as de facto recession in past cycles.

This means that as far as oil prices in 2024 go, Brent could fall to new lows of $60 a barrel.

Matein Khalid is the chief investment officer in the private office of Abdulla Saeed Al Naboodah and the CEO designate of a venture capital firm. He is also an adjunct professor of real estate investing and banking at the American University of Sharjah.

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