A year of sluggish demand and geopolitical risks for oil markets

The current calendar year will go down as the year the oil market convulsed with repeated bouts of geopolitical risk, each one proving to be a lot of hot air in hindsight, but nonetheless hoisting crude prices, crushing refiners’ margins, and penalising consumers at the pump.

Remember the market outlook for the new year when we were turning the page on 2023? With Russian oil supplies efficiently rewired to new markets despite unprecedented Western sanctions and crude prices softening almost $20/barrel on average from the Ukraine war-induced spike of 2022, there was sanguine confidence that 2024 would bring more relief.  

The October 7 Hamas attack on Israel had shaken the oil market, and within weeks, it was clear the Gaza war was going to drag into 2024. But despite the crisis unfolding on the doorstep of the world’s biggest oil-exporting region, there was no anxiety over a supply shock. From a peak above $92/barrel on October 19, Brent futures had tumbled to the low-$70s in December 2023.

Soft landing in the US

A sluggish oil demand prognosis for 2024 (which turned out to be correct) mingled with worries over the Federal Reserve’s ability to engineer a “soft landing” for the US economy with its eagerly-awaited monetary policy pivot (which have persisted through the year) weighed on crude. The post-Covid spurt in consumption was dissipating and two-decade-high interest rates in the US and Europe, coinciding with stubborn inflation, were expected to dampen consumer sentiment.

The OPEC/non-OPEC alliance, contemplating an oversupplied market, deepened ongoing voluntary production cuts by eight members, setting their production target 2.2 million b/d below their collective baseline for 2024. The market saw the move at the end of November as a token gesture and crude shed nearly $10/barrel within 10 days of the announcement.

And yet, here we are – Brent futures have averaged $81.28/barrel over the first 10 months of this year, only a shade below the 2023 full-year average of $82.15.

No market disruption

Neither the Ukraine war nor the Gaza crisis caused any disruption in oil supply on the global market, but the crude price graph of the past 10 months is littered with spikes from knee-jerk injections of a fear premium. The triggers were intensifying Houthi attacks on ships in the Red Sea in January, a spike in Ukrainian drone attacks on refineries deep in Russian territory in March and May, and Israel and Iran launching direct military attacks on each other’s territory in April and October.

The market worked around the Houthi threat in the Red Sea by rerouting vessels with Israeli or Western affiliation via the Cape of Good Hope. It added to the journey time and freight costs but the oil did not stop flowing.

Ukraine’s new strategy of drone strikes deep into Russian territory damaged some refineries and associated downstream infrastructure and forced weeks-long closure of some of the facilities for repairs. It crimped Russia’s refined product exports for brief periods but did cause any fuel shortages in the global market. If anything, this year goes down as one of surplus refining capacity and plentiful fuel supply running into tepid consumption.

Israeli and Iranian attacks on each other’s territory with rockets, drones and missiles were widely described as symbolic, carefully calibrated as they were to avoid casualties and cause minimal damage. The instances of military confrontation did not spiral out of control or draw in neighbouring countries and balloon into a regional war.

Yet, crude surged on panic buying each time the prospect of military hostilities between the two countries appeared on the radar. Crude did not rocket into triple-digits, as some bulls invariably predicted whenever the geopolitical in the Middle East temperature shot up, but prices stacked on up to $10/barrel of risk premium in a matter of days, which is not inconsiderable.

Episodes of volatility

While such episodes of volatility will always be welcomed by speculative traders as an opportunity to make a quick buck, the majority of buyers of physical oil and price-takers in a range of sectors exposed to oil prices are left with the short end of the stick. Every episode of a spike, even if lasting a few days, bumps up the monthly average, which is what the buyers are exposed to, whether paying for a term cargo or a spot purchase.

The higher feedstock costs are passed on to prices at the pump, with the exception of a few regulated markets, where they end up raising the government’s fuel subsidy burden. Higher oil prices also filter through to the broader economy, driving up the cost of goods and services, and in the current environment, rendering the job of central bankers trying to ease borrowing costs harder by making inflation stickier.

The greatest irony of the situation is that consumers and economies around the world end up paying the price of exaggerated fear, while unwittingly bankrolling speculators. They aren’t buying any “insurance”. It is only in the event of an actual oil supply disruption that crude’s additional premium helps tamp down demand and pay for the higher cost of the marginal production that needs to come online, both of which rebalance the market.

One can’t expect market behaviour to change, but one can hope for 2025 to see the end of the two war factors whiplashing oil with fear and anxiety. The US, singly and in partnership with its allies, arguably has the most influence on the Ukraine war as well as the Gaza crisis. One of the biggest and most pressing challenges for the incoming administration of Donald Trump will be to calm down these two festering situations.