That the oil price has taken a mauling this year is evident to anyone with access to a price chart or to the back-numbers of the financial press. Brent crude has lost more than 47 per cent of its value since February and some believe matters can get only worse from here on out.
To them, the question “will the oil price recover?” is best answered with “No”. Or at least, not yet.
Others, however, take the view that crude remains a high-value card in the energy pack, that we are a long way from the “energy transition” that will eliminate fossil fuels and that, for those with strong nerves, now represents a buying opportunity.
A slump will hit oil demand
What ought the sensible trader or investor to make of it all? And when will oil prices recover?
In untangling these questions, it is important to bear in mind that three separate factors, each quite different, impact the price of oil – and, indeed, of any other commodity.
The first is the long-term, “secular” factor. This has nothing to do with people shunning religious belief – secular, in this economic sense, means a long-term trend that is oblivious to both the business cycle and to the sort of one-off events that would, normally, be expected to affect it.
More of that in a moment.
The second factor is the economic cycle itself. As national and, sometimes, the world economies head into recession, demand for commodities of most types will be hit, not just oil but wheat, cocoa, copper… even the intriguingly-named “lean hog futures” traded on the Chicago Mercantile Exchange. Gold is a partial exception, being both a commodity and a monetary asset.
An economic slump, by definition, will reduce demand for oil, both from consumers – unemployed people are likely to economise on their fuel bills – and from business. Traders will react accordingly, marking oil prices down, sometimes sharply, in anticipation of a slide in the value of crude.
A third factor is what can be described as an “exogenous shock”, economist-speak for an event unconnected to the economic system and which comes out of a clear blue sky.
By late 2019, there were increasing warnings that the second factor, the turning of the economic cycle, was imminent after the long expansion that followed the 2008 financial crisis. China was slowing down, the US economy could not continue its breakneck expansion and problems loomed for smaller economies such as the UK.
Traders acted accordingly. The price of Brent crude dropped from $71.24 a barrel on May 14, 2019 to $57.32 by February 14 this year, before the full impact of the coronavirus outside China became clear. It was a similar story for West Texas Intermediate (WTI), where a price of $61.78 on May 14 last year had dropped to $52.05 by February 14.
Tentative signs of recovery
But these declines, driven by recession fears, were dwarfed by what followed the eruption of the third factor, the worldwide coronavirus epidemic. From February 14, Brent dropped to $29.60 by April 14 and WTI fell to $20.11. Widespread lock-down across the developed world threatened a double blow of negligible demand for fuel from transport purposes, as millions remained at home or walked to work. And a catastrophic economic slump was forecast by some in Britain to be not only worse than that of the Thirties but the most severe since the War of the Spanish Succession, which ended in 1714.
Since then, there have been some very tentative signs of oil-price recovery, with Brent trading on May 14 at $30.12, a 3.19 per cent rise on the previous close, and WTI up 2.97 per cent at $26.04 a barrel. Severe cuts agreed by the 13-nation Organisation of Petroleum Exporting Countries (OPEC) and allies headed by Russia helped steady the price, as did the gradual lifting of restrictions in man countries.
However, as mentioned earlier, it is likely to be the long-term, secular trend that holds the key to the question: will oil prices go back up? So what does that trend seem to be telling us?
Cautious optimism for higher oil prices may seem to be in order. Five years ago, on May 15, 2015, Brent was trading at $66.81, more than double today’s levels. Furthermore, the low point during that five years was on April 24 this year, at $21.44.
Momentum seems upwards
But while that may sound gloomy, the April 2020 low was not noticeably worse than the $28.94 seen back on January 15, 2016, and the five-year high was achieved on October 5, 2018 at $84.16.
It was a similar story for WTI. On May 15, 2015, it traded at $59.88 and its five-year low was seen, again, on February 24 this year, at $16.94. But, as with Brent, this is not far off the $29.42 seen on January 15, 2016 and, as with Brent, the five-year high occurred on October 5, 2018, at $74.34.
In other words, the price momentum seems to be generally upwards, despite the coronavirus and the fears of a deep recession. There is certainly no sign of the secular decline in oil prices seen between the mid-Eighties and the end of the century, a decline apparently oblivious to military conflict and a roaring economic boom.
So, to the question when will oil prices rise, the answer is that we cannot be sure. But the chances have to be that they will do so, probably sooner rather than later.