The major factors driving oil prices in the first quarter of this year

US-China trade developments, geopolitical risk and global recession fears can all affect investor confidence

Demand for crude may pick up during the course of the year because of a recovery in the manufacturing and agricultural sectors. AFP

Several large-scale factors are set to shape global oil prices in the first quarter of this year. Developments in the US-China trade dispute, geopolitical tensions in the Middle East, global recession fears and US shale versus Opec cuts all exert a powerful influence on investor confidence in the oil markets.

The pressure cooker of the US-China trade dispute has cooled off after the phase one deal was signed, possibly avoiding further tariff hikes and trade obstacles in the near future and easing investor sentiment. If there are more signals that the negotiating teams are closer to a comprehensive and full trade agreement in the first quarter, it’s reasonable to expect more support for oil prices because the gigantic economies of the US and China would get some breathing space to recover from the damage to their manufacturing and agricultural sectors. This is looking increasingly unlikely if we consider the US elections coming up in November and President Donald Trump’s comments that he is not in a hurry to conclude a final trade deal with China.

Positive results from a boost in confidence may not set in until later in the year. Demand for crude may pick up during the course of the year because of a recovery in the manufacturing and agricultural sectors, both main drivers of demand.

In the last nine months of 2019, US manufacturers and hauliers suffered a sharp decline in growth which impacted demand for petroleum products like diesel. Diesel consumption fell 3.4 per cent in the period August to October 2019 on an annual basis, meaning an overall decline in demand. In addition, although the first phase of a trade deal is signed, China has not yet lifted the 5 per cent tariff on US oil imports.

Even China’s demand for oil weakened slightly in 2019 to 9.5 per cent growth in imports versus 10.1 per cent the year before.

Most institutions such as Opec and the International Monetary Fund are forecasting lower demand for oil in 2020 but there is a chance for demand to pick up if the US and China seal the second deal by the end of the year and give trade relations a fresh start. The impact of the trade disputes on sentiment shouldn’t be underestimated because the prevailing mood since the trade disputes started in summer 2018 has been uncertainty which in turn dampens investment and curbs risk appetite.

Opec deepened its supply cuts at the end of 2019, a period in which the US Shale industry reported a higher rate of bankruptcies in what appears to be an unsustainable level of growth given lower global oil prices. Already, the US market buys domestic oil products and energy imports from overseas have fallen to 11 per cent, the lowest since 1957. Conceivably, the domestic industry could satisfy 100 per cent of US oil demand within the next year, leaving US shale with the question "what next"?

The US is now a serious player in international oil markets and competing hotly for market share, meaning that oil prices are set to stay hemmed in by the push and pull between US shale and Opec, with the exception of geopolitical flare-ups.

The supply-side risk to Middle East oil continues to be a significant factor for investors ever since the flare-up of tensions between the US and Iran in early January.

Fears of a prolonged conflict appear to have calmed but the situation is volatile and uneasy, meaning that oil prices may spike or even slump unexpectedly depending on what happens next.

Looking ahead, a bright spot for prices may be waning recession fears as investors get ready for a more robust post-trade war reality. Global recession fears were behind much of oil’s price weakness last year and may have a long-tail effect in the first quarter before receding further on more positive news from trade talks.

The upside scenario for oil prices would be a definitive resolution to the US-China trade dispute and a reduction of geopolitical tensions. The downside would be a lag between the first and second phase agreement, adding to uncertainty, and an escalation of geopolitical tensions. Investors should expect either scenario to materialise and be prepared for oil prices to react accordingly.

Hussein Sayed is the chief market strategist at FXTM