The huge liquidity overhang created by major central banks in the world after the crisis of 2007-2008 largely changed the behavior of the commodity and financial markets. In this regard, analyzing the oil market, it is necessary to bear in mind that oil is now not just a trading commodity, but a full-fledged financial instrument and the price movements are determined not only by the balance of supply and demand, but also by a number of other factors.
In this regard, special attention should be paid to the following indicators:
The first is the state of global financial liquidity.
Its curtailment causes corrective movements in global asset markets. Let us take a recent example. The actions of Bank of China, which tightened up the conditions for struggling with the shadow debt market, led to an increase in interest rates in the interbank lending market, problems in the banking sector and in turn forced some financial institutions to close positions on commodity exchanges in China and go into cash. Then sales spread to global trading platforms and resulted in a serious decrease in prices of industrial metals and oil in April - early May this year.
Currently an abundance of free liquidity has been created. The total assets on the balance sheet of the world's four largest central banks – the FRS, the ECB, the Bank of Japan and Bank of China are 18.4 trillion in US dollar terms. This is approximately 75% of total assets on the balance sheet of all central banks in the world.
As that the Bank of Japan and the ECB continue buying up assets, the FRS reinvests funds from the repayment of old debts, but does not increase its balance sheet, which is kept at approximately 4.5 trillion US dollars for the third consecutive year. According to the latest minutes of the FOMC it is clear that the discussion on reducing the balance sheet of the FRS will continue at the next meetings and will depend on the incoming statistics. " Nearly all policymakers indicated that as long as the economy and the path of the federal funds rate evolved as currently expected, it likely would be appropriate to begin reducing the Federal Reserve's securities holdings this year. Policymakers agreed to continue in June their discussion of plans for a change to the Committee's reinvestment policy".
In other words, if there is a reduction in reinvestment from the Fed before the beginning of 2018, it is insignificant. With regard to the Bank of China, it makes attempts to reduce the volume of assets on its accounts, but every time everything falls back into place when at first problems occur in the financial markets and then in the real economy.
Such a situation with liquidity cannot last forever and sooner or later liquidity will have to be tightened. Otherwise the potential risks of problems in the credit markets and runaway of inflationary processes can be realized and they will create even more dangerous threats to the global economy. But in the current year and even before the spring of 2018, the volume of global financial liquidity will remain at record high levels. This creates conditions for playing on the upside in the oil market.
The second is demand-supply balance.
According to the US EIA, since 2017 the balance has been shifting towards an excess of demand over supply. The point is that the agreement on the reduction of oil production adopted by the OPEC countries and the countries outside the cartel at the end of 2016 is working and was prolonged on 25 May at the meeting in Vienna for another 9 months until the end of March 2018. Thus, the situation is fixed when with a certain increase in oil demand, the supply will lag behind it.
Theoretically, the USA can increase oil production and make oil supply higher in the world market. However, at the moment there is a clear signal that shale oil extraction will not be able to grow at the same rate as in recent months and the rate of increase in shale production will decline. Another thing is shelf oil in the Gulf of Mexico. This year Donald Trump’s cabinet plans to launch the Continental Shelf Programme, designed for 2017-2022. The volumes coming from this region can lead to a shift in the balance of the oil market towards excessive supply and hence create downward pressure on oil prices. However, this takes time and until at least mid-2018, a significant increase volumes of oil supplies from this region are not expected.
In the near future, the risks of disturbance of the global balance in the oil market exist rather in the direction of limiting supply and, therefore, a rise in oil prices. What is meant here is the political instability in Venezuela. This country produces almost 2 million barrels of oil per day and if the unrests continue and the conflict escalates in this country, the level of production will inevitably decrease.
The third is status of the world economy.
Of course, stalled reflation ideas and domestic political problems of Donald Trump, make investors doubt that the US economy will receive additional support from the tax incentives promised to it by the administration of the new president. This, in turn, calls into question the increase in the rate of economic growth, which should have become the locomotive for the growth of the entire world economy and support the growth of prices for all commodities and oil, including. However, there is reason to believe that by the end of the summer the Trump administration will receive approval of its tax initiatives from the Congress and the Senate. This will bring optimism to the world's trading platforms.
Summarizing the above, we can conclude that the upward trend in the oil market, which began in January 2016, will last at least until the first quarter of 2018. The technical analysis gives a target in the range of 63-67 US dollars per barrel of brent oil. A more accurate picture can be seen when the price of brent oil breaks above the level of 60.