Markets trade on narratives

Oil prices reflect more than simple supply and demand. Bilal Qabalan / AFP
Oil prices reflect more than simple supply and demand. Bilal Qabalan / AFP

Slumping oil prices have financial markets scrambling for answers about the health of the global economy and the likelihood of prices stabilising. China, the consumer of one-tenth of the world’s oil supply, is proving that its thirst for commodities is finite and is scaling back growth forecasts. Iran, newly free from the burden of international sanctions, is eager to start selling its crude on the open market, which will add to the oversupply. All of these factors are having a negative effect on oil prices. That said, commodity markets are fickle by their very nature and price fluctuations are nothing new to oil trading.

Closer to home, we are seeing the short-term effects of the slump in oil prices. Businesses are trimming staff, budgets are being re-assessed and the region’s sovereign wealth funds are exercising caution. However, our local economy in the UAE is in a much better state to deal with lower oil prices than at any other time in the country’s history, even though the commitments of the state have also grown since the 2009 oil price slump.

Only intermittently does the oil market reflect purely the mechanisms of supply and demand. Oil is not set at its marginal cost because producers are choosing to crowd out their rivals. Eventually, marginal cost pricing will return but futures predictions – an imprecise science, about which caution is required – do not expect this to happen before 2023.

Consumers should welcome cheaper petrol and lower airfares. Trade should pick up as transport costs fall, which is good news for ports such as Jebel Ali. But these are side-benefits: the aim of all this oil market tumult is to defend Opec’s market share. The plan all along was to ensure the Gulf’s oil remains the most sought-after as the cheapest to produce. The pain is temporary: maximising the value of future oil reserves is the best way to ensure that Gulf states will be able to keep investing in their economies over the next few decades. Flooding the market is a way to protect future diversification efforts. If it doesn’t hurt, it isn’t working. The pain is worth enduring.

Published: January 19, 2016 04:00 AM