What to Expect From Oil Prices in 2019

Last week I was interviewed by Bloomberg and Rigzone and both news organizations wanted to know where I thought oil prices were headed in 2019. In fact, that’s probably the question I have been asked the most over the past month. Below, I provide details on what I expect.

Let’s first review how to we got to ~$50 oil at the end of 2018. That’s important, because I think it strongly impacts what is likely to happen in 2019.

Why Oil Prices Rose in 2018

In my 2018 predictions, which I will grade in one of my next two columns, I projected that oil prices would reach $70 a barrel (bbl) in 2018. The price of West Texas Intermediate (WTI), the U.S. benchmark, rose to that level in May and remained there for most of the summer. 

There were several reasons I expected oil prices to rise. The threat of sanctions on Iran, global demand that continues to rise, and the deteriorating situation in Venezuela were just three of the reasons I predicted higher oil prices.

But if you had asked me in mid-summer what I expected for the rest of 2018, I would not have anticipated an oil price collapse. The following chart tells the grim story:

As you can see, crude oil prices have plunged over the past year. I largely attribute this decline to a new variable in the oil markets that I call “The Trump Effect.”

The Trump Effect

President Trump has done some good things for the oil industry, but he has a blind spot when it comes to oil prices. He has been vocal about the need to keep oil prices low, even as the U.S. becomes an increasingly important global oil producer.

This would have been an understandable position a dozen years ago, when net imports had reached 14 million barrels per day (BPD). But today, with net imports of crude oil and finished products transitioning into net exports, it’s becoming a different ballgame. 

Low oil prices are a threat to the dream of U.S. energy independence, as they reduce the incentive to invest in new oil production. Low oil prices are also a threat to renewable fuels like ethanol, which become less competitive in a low oil price environment.

Most of the states that benefit from high oil prices are states that voted for President Trump: Texas, Oklahoma, North Dakota, Iowa, Pennsylvania. There are a handful of exceptions, such as California and Colorado, but the oil states are mostly Trump country.

However, President Trump has taken actions that have hurt U.S. oil producers.

Why Oil Prices Fell in 2018

This past summer, China had become a major importer of U.S. oil to the tune of 500,000 BPD. But the trade war with China resulted in China halting imports of U.S. oil. This loss of market hurt U.S. oil producers, and helped push inventories higher in the U.S. This further hurt U.S. oil producers by pushing prices down.

But then Trump also undercut oil producers by waiving sanctions on Iran. Leading up to the implementation of sanctions on Iran that would cut off their oil exports, Trump persuaded Saudi Arabia to begin pumping more oil to compensate for Iran’s pending lost exports.

Then, just before sanctions were set to go into effect, Trump announced that waivers would be given to a number of countries to allow them to continue to import Iranian oil. Among those countries was China, which ironically means U.S. oil producers lost business to Iran as a result of this decision.

Saudi Arabia felt double-crossed by the decision to grant waivers, which resulted in too much oil in the market. The price of oil predictably plunged. But I expect Saudi to approach things differently in 2019. 

Verdict? Higher Oil Prices in 2019

Following the waivers on Iranian imports, Saudi Arabia vowed to cut production. The market wasn’t convinced, and crude oil continued to fall. 

But then OPEC surprised a lot of people by agreeing with Russia to cut a total of 1.2 million BPD of oil from the market. The last time OPEC announced a major cooperation agreement with Russia, oil prices rallied from the $40s up past $70/bbl once it became apparent that the group was sticking to its agreement. 

I expect similar results this time. Jointly, OPEC and Russia produce more than 50% of the world’s oil. They have significant pricing power if they manage to maintain discipline. I expect they will do so given the positive results from the previous production cuts, and therefore I expect the price of oil to recover back above $60/bbl in a few short months. I will be making a formal prediction in a few weeks, but oil at this price looks undervalued given the fundamentals.

As it stands, the joint OPEC/Russia agreement appears to have arrested the fall in the price of oil. Prices had fallen from the $70s to the lower $50s in just six weeks, but seem to have now stabilized above $50/bbl.

I would note in conclusion that there was another draw on U.S. crude inventories this week, which are now 14% lower than they were a year ago. Despite this, U.S. crude oil prices are more than 10% lower than they were a year ago. This is setting up the sort of disconnect I saw in the natural gas markets a few months ago. This disconnect led to a >60% rally in natural gas prices. 

But there’s still the Trump wildcard. As long as he is committed to lower oil prices, he will continue to cajole and coerce Saudi Arabia for more oil production. I expect he will have less success with this approach in 2019.

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