Analysing 3 Scenarios For Oil Futures

Crude oil as an energy resource has dominated the world’s geo-political landscape like no other commodity in the past one hundred years. The leverage that this commodity commands as a geo-political tool far surpasses gold which has ruled the world’s psyche for many a millennium. In fact, it has been referred to as liquid gold in many fictional and non-fictional literature of the present era, accentuating its value to the present-day human civilization.

Human energy consumption has increased exponentially as it has progressed through the path of evolution. Food only is not enough today for humans to survive and if not everything, almost everything else we need in our day to day lives is a guzzler of energy. This hunger for energy has put us on a very dangerous path, where we have reached a point that our present known sources of energy may not be able to sustainably satisfy our needs beyond a certain point. This impending scenario thus has become the most worrisome factor for the decisionmakers and future planners of the present era.

Relationship between Oil Prices and Political and economic events

There has always been a direct correlation between economic events and prices of crude oil and an inverse relationship between political events and crude oil prices. Bad news regarding political unrest or war in some part of the world would spike crude oil prices, while bad economic data coming out of a major economic region will drive down the crude oil prices.

The prevailing geo-political and economic situation around the world today, be it Brexit, trade war between United States and China or recessionary economic conditions in India, is providing quite a complex backdrop so to correctly predict, what direction the world economy might take in the foreseeable future.

Scenario Analysis

One of the tools used by researchers to work through such complex situations is called Scenario Analysis. Here we use different hypothetical future scenarios based on the current understanding of events to predict multiple plausible layouts of the direction the future might take.

This tool is widely used in academia and industry to forecast pricing of scarce resource like crude oil in the short-term, mid-term and longer term.

Below we make a three-scenario analysis based on current prevailing geo-political situation and where the crude prices may head in the short to medium term.

Scenario 1

There is a no deal Brexit in Europe, United States and China trade war intensifies and there is a protracted economic slowdown in India and other parts of South Asia.

This is by far the worst case scenario for crude oil prices. Such a scenario will definitely hamper the world economic growth and depress international trade. As some of the major countries of the world experience a slowdown there will be an oversupply of goods and services in the global marketplace, which will force producers to contract production, which in turn will bring down economic activity. With less economic activity the demand for energy resources will also contract, putting downward pressure on crude prices in the short term.

However, in the mid to long term this pent-up demand caused by the shifting of expenditure phenomenon (it is a observed phenomenon that producers and consumers alike tend to shift their impending capital and non-essential expenses from a recessionary period to a recovery period) will provide support to the crude price to rise after the recessionary conditions subside.

Scenario 2

The United Kingdom is able to enter into a deal with the European union which ensures a less dramatic and smooth Brexit for both parties. United States and China are able to work out their differences and the trade war situation de-escalates.

However, with slowdown conditions are already evident in China , India and also the United States, add to it the effect of the Pre-Brexit turmoil that has already had a defined impact on United Kingdom and in Eurozone, this overall scenario doesn’t look much different from the first scenario.

The difference between the two scenarios, is the time taken for recovery. While in the first scenario the recession will be deeper, with more confusion and ambiguity among investors, the recovery period will be protracted. In the present scenario however, the uncertainty caused by Brexit that had impacted the Eurozone for so long will have subsided and which will bring fresh investments to the region and provide a healing touch to the world economy.

This scenario predicts a moderate growth era in the post Brexit period in the United Kingdom and Eurozone economies, providing some support to crude oil prices. The oil producers will try to mitigate some of the ill effects of the slowdown by cutting down production.

Scenario 3

The downturn conditions in India, China and United states are short lived and the new investment cycle in the United Kingdom and Eurozone is able to overcome the ill effects of the pre- Brexit jitters.

This is by far the best case scenario for the crude oil prices.  This will be a period which will see an increased private and governmental investment in the United Kingdom and Eurozone economies as there will an urgency among the countries to bring their economies to shape following the separation. India, China and the United States will certainly have a role to play in assisting these European countries making the transition.

This scenario will not see much upward or downward transitions to the world economy, but only a shift in priority from one region to another with one experiencing moderate recession and the other experiencing moderate growth.

Crude oil prices in this scenario will follow existing trends giving less scope for speculators, who have been banking on the uncertainties on the global economic uncertainties for some time, to make a quick buck

Other Factors Impacting Crude oil prices

While Global economic conditions and political environment has the maximum impact on the crude oil prices, there are other factors as well which have an impact, primary among them being the production variation brought in by the oil producers from time to time to impact global pricing of this strategic resource.

Other than that, the use of alternatives to crude has increased significantly among the consumers. Due to the increased volatility in oil prices several countries have started to invest heavily on alternatives sources to meet their transportation needs. Natural gas is fast emerging as an alternative to petroleum based transportation fuel. Countries like India and China have invested heavily on developing infrastructure that supports use of natural gas as an alternative to crude oil. Secondly natural gas as a resource is available in far greater quantities in comparison to crude oil and will last several times longer than the world’s crude oil resources.

Apart from this, heavy amount of capital expenditure is being made to develop electric vehicles both by governments and corporations. Several successful examples exist today demonstrating the feasibility of this alternative to oil consuming vehicles. In future as production of these electric vehicles increase, we could very well see the prices of these vehicles coming at par with the price of internal combustion engine vehicles.

There are other aspects as well, new discoveries are being made in Venezuela and in the Arctic regions, which point to the fact that the world reserves of this commodity may be much more than previously anticipated. This information may not be good for people speculating on high crude price regime.

Outlook

The factors other than global political environment and economic conditions that have their impact on crude oil prices has increased in significance over the years. All countries are now aware that this is a scarce commodity and they cannot put their economies at risk by being solely dependent on this resource. Slowly and steadily of course, this commodity is losing its sheen like Gold. However, it will remain a commodity of importance for a long time to come.

In the long run however, as the human race evolves, it will try to completely replace it energy needs from nonrenewable resources to completely renewable resources, so that it will be able completely de- risk its future evolution. Crude oil, till that time, however, will play an assisting role to help us realize that dream.

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