Oil Price Is No Longer the Main Indicator. What Should Investors Watch Instead?

U.S. investment bank JPMorgan wrote in a September 17 note that, for the first time since the start of the U.S.-Israeli war with Iran, it could no longer establish a clear baseline view for oil markets. “We simply don’t know how to model the endgame,” Reuters quoted the bank’s analysts as saying.

At the time, JPMorgan estimated the fair value of Brent crude at around $90 a barrel, compared with a market price of about $106. On September 29, the November Brent futures contract was trading at around $105.8 a barrel.

Does JPMorgan’s admission mean traditional oil-market forecasting is becoming less useful? Should investors still rely on a single base-case oil-price forecast, or is scenario analysis now more appropriate? And which indicators should investors watch most closely?

Energy Finance Analyst, Australian Oil and Gas at the Institute for Energy Economics and Financial Analysis (IEEFA) Kevin Morrison shared his view with Oninvest.

Traditional oil-market forecasting models are not becoming less useful. But there are a number of factors that make the current energy crisis different from the others we have seen in the past.

The global oil and gas markets are dealing with two major conflicts involving significant oil and gas producers, and they are unlike conflicts we have seen in the past that have impacted energy markets. This is due to technological changes that have seen relatively cheap drones become effective weapons of war that can cause significant damage to energy infrastructure, and this in turn is impacting global energy supplies.

At the same time, technological changes in energy have also seen cheaper forms of energy emerge in the shape of solar photovoltaic and grid-scale and home batteries. These are providing an alternative to gas-fired electricity generation, as well as the option of switching back to coal-fired power generation.

This means that energy markets are more dynamic and more competitive. This is also happening in the oil market to a lesser extent, with sales of electric vehicles surging as drivers do not want to be exposed to the uncertainty associated with oil markets.

This will increasingly be a permanent factor in oil and gas markets, and not a temporary situation associated with the bombing of Iran by Israel and the US.

Scenario analysis is a more appropriate way to look at the current oil and gas markets as there are so many variables, and nobody quite knows what is going to happen next.

There is uncertainty over when there will be a long-term solution to restoring maritime traffic through the Strait of Hormuz, or a resolution to Russia’s invasion of Ukraine.

Then there are other variables, such as whether the US imposes a diesel export ban. All of these will have profound impacts on energy markets.

It is therefore best to talk in terms of possible scenarios rather than some categoric future outcome.

By talking about scenarios, we can discuss a price range, as each scenario will have a different price outcome.

Investors also need to have a better geopolitical understanding of the current conflicts. So far, the commentary from political leaders has been dominated by President Trump, but this conflict is complex and involves multiple players with different agendas.

These different players and their agendas need to be understood rather than relying on soundbites from President Trump.

There is also a structural change to oil and gas markets, with record EV sales, including electric bikes, impacting demand. This has to be incorporated into future gasoline demand in the near term and diesel demand in the longer term.

Physical oil flows, tanker traffic and inventories are key, and data is important.

There have been conflicting reports on tanker traffic through the Strait of Hormuz, as well as through the Red Sea routes from Saudi Arabia’s Yanbu port on its west coast via the Mediterranean Sea and south through the Bab el-Mandeb route, which is subject to attacks from the Iranian-backed, Yemen-based Houthi militia.

Inventories are important, particularly US inventories as the world’s largest oil producer. The level of inventories leaves only a shallow cushion should there be any major oil production outage in the US.

The US Strategic Petroleum Reserve has fallen to 283.8 million barrels, its lowest level since October 1982, Reuters claimed.

The current environment therefore calls for a broader approach to the oil market: rather than relying on a single central forecast, investors need to consider different scenarios and closely monitor physical oil flows, tanker traffic, inventories and geopolitical developments.