The Bottom Line:
- Geopolitical tensions and supply disruptions, including the Russia-Ukraine war and OPEC production cuts, threaten to drive oil prices higher.
- However, the rise of renewable energy and increased production from the US and Canada provide some insulation against major supply shocks.
- Long-term demand for oil is expected to remain strong, driven by the industrialization and development of emerging economies like India and China.
- Short-term oil prices are closely tied to US manufacturing activity, with recessions potentially leading to significant price declines.
- Technical analysis suggests a period of price contraction, indicating a potential breakout in either direction in the near future.
Geopolitical Tensions and Supply Disruptions
Rising Tensions and Fragile Alliances
The global geopolitical landscape is undergoing significant shifts, with new alliances forming and tensions escalating between major powers. At the center of this changing world order lies oil, one of the most sought-after commodities. From military conflicts to supply shortages and price manipulation, the new world order risks leading to unprecedented volatility in the oil market. The war in Ukraine has led to a complete cut-off of Russian oil exports to the West, resulting in a significant jump in oil prices in 2022. With no signs of the conflict abating, it is unlikely that European or American imports of Russian oil will resume anytime soon.
OPEC’s Declining Production and Potential Supply Shocks
In addition to the Russia-Ukraine conflict, OPEC, which accounts for approximately 40% of the world’s oil production, has been steadily reducing its output since 2018. This marks the longest period of declining production since the 1980s, an era known for spikes in oil prices. If Russia and OPEC members, together representing over 50% of the world’s oil supply, continue to limit their supply to the rest of the world, it could lead to oil shortages and drive prices significantly higher. A prime example of such a scenario occurred following the Iranian Revolution in 1979, when Iranian oil was entirely cut off from the Western world, causing oil prices to triple instantaneously.
The West’s Insulation and the Role of the US and Canada
While there are concerns about potential supply shocks, the Western world appears to be somewhat more insulated from such events than in the past. This is largely due to the United States and Canada ramping up their own oil production over the last couple of decades. The US and Canada have tripled their oil production capacity and now produce about as much oil as Saudi Arabia and Russia combined. However, for a situation similar to the 1979 Iranian Revolution to occur today, Western powers would need to be completely cut off from all Middle Eastern oil, including that from Saudi Arabia, the UAE, Kuwait, Iraq, and Qatar. Such a complete cut-off seems unlikely in the current context.
The Rise of Renewable Energy and Increased Production
The Steady Rise of Renewable Energy
Despite the concerns surrounding oil supply and geopolitical tensions, the global energy landscape is witnessing a significant shift towards renewable energy sources. The share of oil in global energy consumption has been steadily declining since the 1970s, while the adoption of renewables such as solar and wind power has accelerated in the last decade. This transition towards cleaner energy sources is driven by increasing environmental awareness, technological advancements, and supportive government policies.
Growing Oil Demand in Emerging Economies
While the rise of renewable energy is promising, it is essential to consider the absolute increase in global energy consumption. When adjusting for this factor, it becomes evident that the total demand for oil has significantly increased since the 1970s, and there is still substantial room for growth, particularly in emerging economies. Countries like India and China have seen their oil consumption rise rapidly as they continue to develop and industrialize. India’s oil demand, for example, has grown to six times its 1980 levels, yet it remains a fraction of that of the United States. As these developing countries continue to catch up with the West, their energy needs will likely increase, further driving up the demand for oil.
The Short-Term Outlook and Economic Indicators
In the short term, oil prices are closely tied to US manufacturing economic activity, as evidenced by the strong relationship between the ISM Manufacturing PMI and the price of oil. The next significant move in manufacturing data will likely determine the trajectory of oil prices in the medium term. Recessions, such as those experienced in 2008 and 2020, can cause manufacturing activity to grind to a halt, leading to substantial downward pressure on oil prices. The likelihood of a global recession in 2025 remains a topic of heated debate and will be a determining factor in whether oil prices can resume their upward trend. From a technical analysis perspective, the current pattern of lower highs and higher lows, known as contraction price action, suggests that the market is building up energy for a substantial move in either direction.
Long-term Demand for Oil Driven by Emerging Economies
Emerging Economies as Key Drivers of Long-Term Oil Demand
While the rise of renewable energy sources is expected to gradually replace oil as the primary source of energy, the total demand for oil has actually increased significantly since the 1970s. This is largely due to the rapid growth in energy consumption in emerging economies. As these countries continue to develop and industrialize, their energy needs are expected to rise, further driving up the demand for oil.
India and China: Substantial Room for Growth in Oil Consumption
India’s oil demand, for instance, has grown to six times its 1980 levels, yet it remains a fraction of that of the United States. As India continues to catch up with developed economies, its oil consumption is likely to rise further. Similarly, China’s oil consumption has grown from about a fifth of that of the United States in the late 1990s to representing about 15% of global oil consumption today. However, given China’s population size, which is five times larger than that of the United States, there is still significant potential for growth in its oil consumption.
The Need for an Unprecedented Surge in Renewable Energy Adoption
Unless there is an unprecedented surge in renewable energy adoption over the next few decades, the sustained upward pressure on oil demand from developing countries is likely to continue in the long term. This could potentially drive oil prices higher. However, it is important to note that these are very long-term trends and are unlikely to have a significant impact on oil prices in the short term.
Short-term Oil Prices Tied to US Manufacturing Activity
US Manufacturing Activity: A Key Indicator for Short-Term Oil Prices
In the short term, oil prices are closely tied to US manufacturing economic activity. The ISM Manufacturing PMI, which measures the level of manufacturing activity in the US, has a strong relationship with the price of oil. When manufacturing activity is robust, oil prices tend to rise, and conversely, when manufacturing activity slows down or contracts, oil prices often follow suit. The next significant move in manufacturing data will likely determine the direction of oil prices in the medium term.
Recessions and Their Impact on Oil Prices
Recessions can have a profound impact on oil prices, as evidenced by the events of 2008 and 2020. During these periods, manufacturing activity ground to a halt, causing oil prices to move down substantially. The global economy’s potential to experience a recession in 2025 is a topic of intense debate among economists and market analysts. The occurrence or avoidance of a recession will be a crucial factor in determining whether oil prices can resume their upward trajectory or face downward pressure.
Technical Analysis: Contraction Price Action and Potential Breakouts
From a technical analysis perspective, the current oil price movement lacks a clear sense of direction, as indicated by the price hovering around its moving averages without a distinct upward or downward trend. The market is exhibiting a pattern of lower highs and higher lows, known as contraction price action. This setup often precedes a significant breakout in either direction, as the market builds up energy for a substantial move. Traders looking to capitalize on this potential volatility can wait for a breakout before initiating a trade, using stop-loss orders to manage risk. By placing stop-loss orders just below the lower trend line for long positions and just above the upper trend line for short positions, traders can limit their potential losses if the breakout fails to materialize.
Technical Analysis Suggests Potential Price Breakout
Contraction Price Action and Potential Breakouts
From a technical analysis perspective, the current oil price movement lacks a clear sense of direction, as indicated by the price hovering around its moving averages without a distinct upward or downward trend. The market is exhibiting a pattern of lower highs and higher lows, known as contraction price action. This setup often precedes a significant breakout in either direction, as the market builds up energy for a substantial move.
Trading Strategies and Risk Management
Traders looking to capitalize on this potential volatility can wait for a breakout before initiating a trade, using stop-loss orders to manage risk. By placing stop-loss orders just below the lower trend line for long positions and just above the upper trend line for short positions, traders can limit their potential losses if the breakout fails to materialize. This approach allows traders to take advantage of the market’s momentum while minimizing their exposure to adverse price movements.
The Role of Capital.com in Commodity Trading
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