Don’t Be Fooled By The Recent Fall In Oil Prices

Yesterday, business newswire Marketwatch published an interesting article titled ‘Oil ends at lowest level in a month as hope dims for production freeze.’ The article, as its title suggests, spelled out how oil had fallen in recent times.

This is evident from the chart below, which illustrates changes to the price of oil since the middle of February 2016. One key thing to note about the chart is the nine consecutive days of declines in the price of oil after it had broke above a level of US$40 per barrel in late March.

Short Term Oil Prices
Source: Daily FX

Should investors be worried about this recent development in the price of oil? Thing is, I think many investors often place too much emphasis on the short-term price volatility of oil and neglect the bigger picture.

The longer term view – seen in the next chart below – puts the nine consecutive business days of oil price declines into perspective. The price of oil had staged a strong recovery since February this year (the black box) and investors should not be distracted by normal short-term volatility of the kind we had witnessed in the nine-day losing streak.

LongTerm Oil Prices 2 (1)
Source: Daily FX

In my view, the latest nine-day fall had come from a tussle between Saudi Arabia and Iran over each other’s supply of oil. Iran had recently emerged from US oil sanctions and is likely eager to make as much profit as possible by selling its oil. In fact, Iran has declared that it wants its oil production to return to pre-sanction levels.

Currently, there appears to be an excess supply of over 1 million barrels of oil per day in the oil market. If Iran wants to increase its oil production, it’d imply that other countries would have to cut their production in order to not worsen the oversupply situation.

This opens the stage for tricky negotiations internally between OPEC (Organisation of the Petroleum Exporting Countries) members to balance their interests (Iran is part of OPEC). Saudi Arabia, one of the important members within OPEC, has demonstrated that it has the deep pockets and determination to withstand lower oil prices and put other errant producers in line.

A Fool’s take

But, it is in the overall interest of OPEC countries, in my view, to cut their oil supply to support oil prices. This does not preclude OPEC members from jostling with each other for advantage periodically. However, I think group dynamics would still reign over time and ensure that everyone toes the line.

Hence, I don’t think investors should be overly concerned about short-term volatility in the price of oil. They are simply used as a bargaining tool by countries and as I had explained, I think the worst is likely to be over for the price of oil. This could be good news for local oil & gas-related companies such as SembCorp Marine Ltd (SGX: S51), Ezion (SGX: 5ME) and Keppel Corporation Limited (SGX: BN4), among others.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Ong Kai Kiat does not own shares in any companies mentioned.