Events to Watch: Geopolitical risks to the oil supply picture in 2018

In our recently released report FSG’s Events to Watch for 2018 we profiled the downside and upside scenarios that may imperil the strategic initiatives and revenue targets of multinationals. Over the next few weeks, we will be sharing a series of blog posts that highlight some of the major global events, and the potential impact on MNCs.

Click here for part 1 – Prepare for Trump-driven trade conflict in 2018

Oil prices are a major driver of the global economic outlook, with FSG’s base case for 2018 indicating range-bound average oil prices of $58 Brent  and $54 WTI. However, oil markets are subject to disruptive events. Given that demand for oil is relatively price inelastic, unexpected changes to oil supply can trigger large changes in oil prices. Large changes in oil prices can have significant spillover effects to individual countries, regions, and to the global outlook. FSG highlights two supply-side risks to the global outlook: in one scenario, the OPEC quota arrangement falls apart, flooding the markets with an oversupply of oil that depresses world prices. In another scenario, an oil supply shock drives up global prices.

Source: Frontier Strategy Group

OPEC Deal Dismantled: OPEC members, alongside some non-OPEC countries like Russia, have restricted their oil production since November 2016 to reduce a supply glut in the markets. The expected impact was a reduction in global inventories and an increase in prices, and since the summer, global inventories have declined, and prices have increased almost $20/bbl. If OPEC members decided to abandon these production quotas, then the market would return to oversupply, depressing global oil prices. The concern is that OPEC members, many of whom are running current account deficits, will seek to benefit from current prices by increasing oil exports. A sudden increase in OPEC production could push the market back into oversupply and a dramatic collapse in prices.

The short-term impact for multinationals would be the following:

  • Lower operating costs – Companies would benefit from lower manufacturing, transportation, and travel costs.
  • Short-term boost to oil importers – Importers would benefit from lower energy prices and import costs, which in turn reduce pressure on consumer prices.
  • Significant pressure on oil exporters – Exporters worldwide would face lower prices, increasing pressure on government spending and social stability

Likelihood: 15%. Saudi Arabia seems committed to maintaining the production quota, and no one wants to return the markets to the severe oversupply (and subsequent low prices) that occurred in 2015-2016. Short of the full cancellation of the quota arrangement, OPEC members and their partners may selectively opt to increase output beyond their quotas, reducing total compliance but having a more limited impact on the global supply picture.

How to prepare: MNCs with significant exposure to oil exporters should evaluate their sensitivity to a collapse in oil prices and local currency exchange rates.

Oil Supply Shock: In the past few months, global oil markets have been reminded that oil supply is subject to geopolitical risks. Major oil exporters like Venezuela, Iraq, Iran, Libya, Saudi Arabia, and Nigeria could see significant supply disruptions over the next year. Global supply growth and inventories can only offset a limited amount of unexpected output declines before the impact on prices becomes dramatic. If these outages are seen as temporary in nature, then swing producers (OPEC and US Shale) may not take steps to increase supply that would pull prices back down.

The short-term impact for multinationals would be the following:

  • Short-term boost to non-disrupted oil producers – Oil producers that are not subject to supply disruptions will benefit from higher oil prices and improved market share, though this benefit is only short-term.
  • Significant pressure on oil importers – Importers face significant short-term spikes in oil prices and import costs, which will suppress growth and increase inflation.
  • Higher operating costs – Companies face margin pressure from sharply higher manufacturing, transportation, and travel costs

Likelihood: 15%. There is a good chance that some unexpected outages will occur, but it is unlikely that these outages will result in sharply higher oil prices. Oil production forecasts for 2018 indicates that the markets will be slightly oversupplied. The IEA forecasts that markets will be oversupplied by 400,000 bp/d on average in 2018, if OPEC cuts are maintained. If we still see supply shortfalls, Saudi Arabia and other OPEC producers may respond by increasing output in order to retain market share.

How to prepare: Be cautious not to change strategic plans too quickly because of oil price movements. Many exporting countries have made (or are making) structural shifts to adapt to a low-price environment, and local consumers and business confidence may not result in immediate benefits to MNCs.

For more information

Clients can access our Events to Watch for 2018 report for in-depth scenarios, expected impact on business performance and operations, as well as recommended frameworks for contingency planning and effective market monitoring. Not a current client? You can purchase a copy on FSG’s online store here.

We also invite you to register and join our Events to Watch for 2018 webinar, presented by FSG’s Director for Global Economics, Antonio Martinez, and Global Head of Research, Joel Whitaker. Please register for the viewing time of your choice:

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