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Focus on crude oil: Prices are likely to rise again after turbulence

Oil prices experienced some turbulence in late 2018: oil prices fell across the globe. A deterioration of the fundamental aspects and high volatility were the causes of this price drop. But how will the price of crude oil develop in the new year?

Almost no price changes at the gas pump despite falling crude oil prices

Crude oil prices for the WTI type have fallen by just under 30 percent over the last few months of 2018. At the gas pump or when filling their heating tanks, however, the Swiss will have noticed virtually no price change, or at least nothing of this magnitude. According to the Swiss Petroleum Association, unusually high transport costs are a particular obstacle to any decline in prices. For example, the cost of transporting oil via the Rhine has in some cases risen tenfold due to low water levels. Switzerland obtains 15 percent of its heating oil, 25 percent of its gasoline, and more than 60 percent of its diesel via waterway. 

High volatility affects the oil markets and oil prices

The oil market has experienced a turbulent period recently: Since the start of October 2018, both the West Texas Intermediate (WTI) and Brent types have declined by more than 20 US dollars, and are now trading at just over 50 US dollars, respectively 60 US dollars. One decisive factor was the high volatility, which increased sharply during that time.

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Return volatility of crude oil prices rose sharply in October 2018

Last data point: December 7, 2018

Source: Bloomberg, Credit Suisse/IDC

Crude oil prices are likely to increase

The oil market slump has coincided with the deterioration of certain fundamental aspects, such as the granting of exemptions from Iran sanctions, a significant negative revision of supply-demand estimates on the part of energy agencies, and weak seasonal factors. But will these factors prove enduring negatives, or is it more a case of the market overreacting? The most important factors that speak for a price increase are listed below:

  • OPEC
    In expectation of strict enforcement of US sanctions, the Organization of the Petroleum Exporting Countries (OPEC) increased its production too strongly in October 2018. The OPEC created a supply overhang in the market, whereas in fact the US decided on a change of direction at the last minute when it came to actually applying sanctions against Iran. At the OPEC meeting on December 6, it was agreed to cut output by 1,2 million barrels a day, higher than market estimates. This should restore balance to the market in the first half of 2019.
  • Iran
    The market initially priced in a huge decline in Iranian oil exports (of more than 1,25 million barrels per day), but has since adjusted its expectations in this respect to some 0,5 million barrels per day or less. The supply of Iranian crude oil will fall significantly over the next few months, albeit in a very staggered way. It is also conceivable that the US government will decide to resume a harsher line in respect of sanctions implementation.
  • Supply-demand estimates
    The reduced estimates for consumption could prove to be more enduring, particularly in view of the rising uncertainty over the future strength of macroeconomic development. However, the upwardly revised estimates for supply are now likely to be reversed, as drilling activities continue to be price-sensitive. As the upward revisions of supply came at a time when WTI crude was trading at around the 75 US dollar level, it is only logical to expect downward revisions as the next development.
  • Seasonality
    Toward the year-end of 2018, seasonal factors added their weight to upward pressure on oil prices. After a seasonal buildup in US inventories, as local refineries concluded their maintenance work in October/November, refinery activity is expected to pick up again. This implies a renewed reduction in inventories which should ultimately lead to a rise in prices.
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WTI crude oil futures prices fell in late 2018

Last data point: December 7, 2018

Source: Bloomberg, Credit Suisse/IDC

Outlook for 2019 – crude oil forecasts look good

According to the Credit Suisse experts, the demand for commodities is likely to remain strong, while inventories are expected to shrink further. This is an indicator of rising prices for cyclical commodities, particularly crude oil. From the investor’s perspective, structured products on crude oil futures offer a way of profiting from the high volatility of the current environment. Another way of gaining exposure to this sector is to invest in energy stocks. Results unveiled for the third quarter have confirmed that energy sector earnings are continuing their strong recovery, and the great majority of the Credit Suisse top picks in this area have recorded earnings growth in double-digit percentage territory.