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Oil price chart.

Oil Prices and What Traders Should Know

Oil markets continued to fall Friday as persistent concerns about a glut in global supply were affected by weaker economic conditions.

Saudi Arabia, which doesn’t want to take all the pain by itself, may struggle to convince producers like Russia and Iraq to join in making cuts. The Saudis must navigate a route between the pressures from their market’s need for revenue and the U.S. government’s need for lower oil prices.

The Trump government has relied on Saudi Arabia to increase output, and convince other producers to pump more oil, to be able to offset the inflationary effect of its hawkish Iran policy.

Volatility is also high in energy markets with WTI reaching levels not seen since the 2014-2016 market slump.

U.S. politicians have been dominated by the line of thinking that goes we don’t want to upset a country that’s spending hundreds of billions of dollars inside our country and who has helped us keep oil prices down so they’re not going to $100 and $150 dollars per barrel. We have oil prices where we want. We’re not going to ruin the world market, by being foolish with Saudi Arabia and destroy our own economy in the process.

What if Saudi Arabia decided to cut production so as to jack up prices in retaliation for punishment from Washington? It would be painful to Saudi Arabia. Cutting production and exports could decrease sales for Saudi Arabia; higher costs would spark a much stronger response from U.S. shale; higher costs would help Iran (Saudi Arabia’s enemy); and higher costs would also put pressure on the U.S. to issue more waivers on importing oil from Iran so as to alleviate market pressure. All this would be negative for Saudi Arabia therefore it would not happen. But even if the U.S. completely cut ties with Saudi Arabia and Saudi Arabia decided to punish the U.S. by sending all its oil to China instead of the U.S., that would only displace oil going from, say, Iraq into China. Iraqi oil would then go to the U.S. and the final result would be minimal.

For some reason, American officials have long believed that we have to appease Saudi Arabia because they hold all the cards and could devastate our economy if they wanted. That’s not really true but the fear in Washington continues.

In the course of mere weeks, crude prices went from a four-year high into a full-blown Bear market.

Oil price chart.

Pressure is building on OPEC to shore up costs once the organization gathers in Vienna, along with Russia and other oil producers, in early December.

Crude oil prices have observed ups-and-downs this season, with prices spiking to multi-year highs in October because of Trump’s decision to reimpose sanctions on Iran. The threat of sanctions on Iran has put upward pressure on oil prices during much of the year. The reimposition of sanctions on Iran threatened to take a great quantity of oil off the market from one of the largest oil producers in the world.

Over the summer, the Saudis and other producers, who were controlling output opened the taps, to ease worries that Iran sanctions would push the price of oil much higher.

President Trump, after the Saudi’s and OPEC cut production, suddenly announced that some countries could continue to buy Iranian oil. The Trump Administration shocked the petroleum market by taking a softer approach on Iran. Waivers were granted, allowing China, India and other nations to continue buying crude from Iran.

Saudi Arabia was convinced by the Trump Administration that Iran’s oil exports were headed to zero, or close to zero, so Saudi Arabia ramped up oil supply to offset the losses. Well play President Trump but Saudi Arabia was not too happy at being duped into increasing oil production. The Iran headfake caused a sudden supply glut. OPEC will cut oil output at next month’s meeting to help put a floor under the price of oil.

Traders have shifted their attention from Iran to other factors, like whether the United State’s trade war with China and rising interest rates could dampen global economic growth and demand for oil.

President Trump is pleased about the slide in oil prices, but Saudi Arabia clearly is not. Saudi Arabia and its OPEC partners will take action to push up oil prices by cutting supply. It is clear that Washington and Riyadh have very different objectives.

Although Trump praised Saudi Arabia for lowering oil prices, his tweet omitted the fundamental role played by America in the oil dip. Lifted by the shale drilling oil boom, the United States overtook Russia and Saudi Arabia to become the world’s biggest oil producer for the first time since 1973.

Oil output has risen despite war in Libya, and it’s held up better than expected in Venezuela. Oil stored in storage tanks has started to build again, increasing fears of a glut.

However, this oil recession is not solely about excess supply. The downturn in economic growth seems to be denting demand. The International Energy Agency predicts US output will have jumped by over 2 million barrels a day in 2018. It is anticipated to rise even further. No other nation has ramped up oil production like the US.

An oil rally is on the way with talk of OPEC announcing a production cut at its December 6, 2018 meeting.

After cutting imports to zero in expectation of sanctions, Japan and South Korea may start buying oil from Iran in January.

JP Morgan has cut its outlook for petroleum, forecasting that Brent crude prices will average $73 a barrel in 2019, down from the previous forecast of $83.50 a barrel.

OPEC should announce an oil production cut by 1.2 million barrels per day when they meet in Vienna on December 6, 2018.

A couple of months ago the Saudis steered oil prices back to what were, for their own purposes, more comfortable price levels by orchestrating output cuts with Russia and other oil producers. Now, Saudi Arabia and Russia are being squeezed by oil producers in the US.

It may be tough to convince Iraq to cut oil production, but it appears like Russia may already be on board. Energy minister Alexander Novak said he is currently considering production cuts.

Global GDP is forecast to slow from 2.9% in 2018 to 2.5% next year.

The appetite for oil in the U.S. has been robust, however, the IEA warned of weakening demand in Europe and developed Asian countries. The IEA also forecast a slowdown in oil demand from India, Brazil and Argentina due to high costs, weak currencies, and deteriorating economic conditions.

President Trump does not seem to think oil is at a price to where it begins to hurt domestic oil producers. Keep in mind that a big part of the oil and gas business is the voting base of President Trump.

JP Morgan expects the purchase price of Brent to go toward $64 in 2020.

The sudden retreat in oil prices, which brings back memories of the industry-rattling oil crash in 2014, is a huge worry for members of OPEC whose economies are closely tied to oil revenues. I think it’s a given that Saudi Arabia and OPEC will cut production next month.

There’s talk of possible EU sanctions on Iran, and it is likely the market will still lose appreciable quantities of Iranian crude in the coming months.

There were large moves for China’s oil majors, with concern about slowing growth and the possible financial effects of the trade war with the US adding to stress. Cnooc fell 1.6 percent and PetroChina was down 0.9 percent.

Cnooc stock chart

Petrochina stock chart

The Bear market in oil gives leverage to those OPEC leaders who have expressed a desire to decrease production in recent weeks. Saudi Arabia will point to the price of oil as a powerful argument for why OPEC nations should agree to curb oil production and abide by the production cuts. Saudi Arabia will assert that production cuts are needed to stave off the possibility of future oil price declines that will be disastrous for oil producing countries.

Russia will decide that moving along with oil production cuts is within their self-interest. Putin will make the exact same call as he did in November 2016 and choose to partner with OPEC producers due to domestic financial considerations.

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