macroeconomic risks for the oil industry
Last Updated : GMT 05:21:58
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Last Updated : GMT 05:21:58
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Macroeconomic risks for the oil industry

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Arab Today, arab today Macroeconomic risks for the oil industry

An oil pump is seen operating in the Permian Basin near Midland, Texas
London - Arabs Today

The global oil industry now appears to be in the early stages of a cyclical expansion which is likely to see prices rise over the next few years, slowly at first but then accelerating later.
Deep and long cycles in oil prices have been the defining characteristic of the industry since the 1860s. The boom-bust cycle, which started in late 1998, with prices briefly below $10 per barrel, and was only briefly interrupted by the recession of 2008/09, ended in January 2016, with prices briefly below $28. In the 18 months since then, the industry has returned to an expansion phase, with a gradual increase in prices and drilling activity, much of it centered on the shale plays of North America.
Most of the industry’s cyclical indicators (production, consumption, stocks, investment, employment, prices, costs) point to a sustained upswing in the activity that is likely to continue in the short and medium term.
Forecasting future movements in oil prices will always be subject to an enormous amount of uncertainty owing to the complex and non-linear dynamics of the oil market and all its sub-systems. “We have never been any good at predicting these cycles, neither when they occur nor their duration. We don’t spend a lot of time even trying,” Rex Tillerson observed in 2016 when he was still chief executive of Exxon.
“How the future is going to look, we take no particular view on it, other than to recognize that whatever it is today it will be different sometime in the future, and after that it will be different again.”
Price predictions have proved a regular graveyard for the reputations of even the most skilled oil analysts. But with the oil industry just emerging from the deepest slump in a generation, cyclical positioning strongly suggests that prices are more likely to move higher rather than lower in the next few years.
The industry’s costs, which have always been pro-cyclical, are also likely to rise as the slack carried over from the downturn is absorbed and the supply chain tightens.
The main uncertainty centers on how far and how fast oil prices and the industry’s costs will rise in the years ahead. Experience suggests the expansion is often slow and faltering at first and then accelerates as inherited slack is used up, memories of the downturn fade and confidence improves.
The principal risk in the short term is that the prices and drilling rise too far too quickly, overwhelming growth in consumption, and sending the industry back into a slump.
The principal medium-term risk comes from the global economy, with the increasing probability of a recession in the advanced economies sometime before the end of the decade.
The current economic backdrop is exceptionally favorable for the oil industry, with a sustained expansion in business activity and a gradual acceleration in trade flows in most regions of the world. But the major economies, like the oil industry, are subject to long and deep cycles in activity, which have an impact on oil demand and prices.
Unlike the oil industry cycle, which is in the early stages of expansion, the macroeconomic cycle in many of the advanced economies looks increasingly mature.
Moreover, the expansion phase of business cycles seems to have been getting longer, perhaps because businesses are getting better at managing investment plans and inventories, or because policymakers have a better understanding of how the economy works.
The current economic expansion was preceded by the deepest slump since the 1930s in the US, so the economy started with more slack than usual, which may make the expansion sustainable for longer. Nonetheless, the expansion in the US and some other major economies is starting to look fairly mature, with low levels of unemployment, high business profits, and signs of frothiness in financial markets.
For the Federal Reserve and most other major central banks, the question is not whether to tighten monetary conditions, which remain very accommodative, but how soon and how aggressively. It is not safe to project current economic and financial conditions unchanged into the future without recognizing the economy is subject to almost as much cyclical variability as the oil industry itself.
So any medium-term forecast for the oil industry must take into account the increasing probability of a slowdown if not a recession in the advanced economies toward the end of the decade. It is an open question whether a cyclical downturn in the advanced economies would spill over into developing economies that now account for more than half of global oil demand. But in an integrated global trading and financial system, there is a strong likelihood a slowdown in the US and other major economies would spread, magnifying the impact on the oil industry.
The challenge for the oil industry is that its own early or mid-stage cyclical expansion could coincide with the late-stage of the macroeconomic cycle in the advanced economies and a tightening of global credit conditions.
Risks from the macroeconomy are probably fairly limited in 2018 but will become progressively more important in 2019 and 2020 as the business cycle becomes increasingly mature.
•John Kemp is a Reuters market analyst. The views expressed are his own.

Source: Arab News

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