The crisis in the Middle East and oil prices

We expect oil prices broadly to stabilise in 2017—but prices will continue to be affected by geopolitical shocks in the region, which will also create tremors on financial markets.

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Oil currently seems to have reached its fair value at around USD50 per barrel for Brent crude. We expect prices to average around USD55/b in 2017, while supply continues to adapt to sluggish demand. The agreement between OPEC members on 30 November and with non-OPEC producers a week later should reinforce the trend toward stabilisation, as long as participants comply. Saudi Arabia agreed to a higher production quota for its rival Iran while accepting to curb its own output – an act of appeasement between two countries whose leaders could barely have conceived of such an idea just weeks before. Russia also agreed to curtail output. Whether such an agreement stands the test of time remains to be seen.

In any event, due to underinvestment in the oil industry over the past two years, we are unlikely to see a massive oversupply—except in the event of a global economic crisis—and therefore a lastingly lower oil price environment. Overall, oil prices at around USD55 per barrel should boost the stock markets, enabling energy earnings to continue their rebound without overburdening broader economic growth. At the same time, however, there is an upper price limit beyond which unconventional hydrocarbon producers are ready to return en masse, particularly US shale drillers, who can resume production at relatively short notice.

Given the negative correlation in place between oil and equities since last year, a geopolitical détente in the Middle East will also contribute to stable or higher crude prices. However, we expect geopolitical instability in the Middle East to remain high in 2017. Saudi Arabia and its partners may not be prepared to stand by and watch their allies suffer defeat, as seems to be happening in Syria. Meanwhile, the election of Donald Trump casts US policy in the region into question, with obstacles to a mooted US rapprochement with Russia and contractions in Trump’s hardline stance on Iran. All in all, numerous factors will sustain a degree of uncertainty and risk surrounding oil prices and financial market volatility this year.

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