Oil Prices Remain Volatile Amid Geopolitical Tensions

Oil prices have remained highly volatile amid geopolitical tensions, reflecting the complex interplay between supply and demand dynamics, economic data, and global uncertainties. Recent conflicts in the Middle East and the ongoing Russia-Ukraine war, have heightened fears of supply disruptions, driving up the risk premium and supporting higher oil prices.

At the same time, U.S. economic resilience and potential Federal Reserve rate cuts have bolstered short-term demand expectations, contributing to price fluctuations. This article provides a fundamental and technical overview of the oil market to identify its next direction.

Geopolitical Uncertainty Drives Oil Market Volatility

Geopolitical shocks impact oil prices directly and indirectly. These shocks create uncertainty about the global economic outlook, reducing consumption and investment. This diminishes global economic activity and lowers oil demand, causing prices to drop. On the other hand, geopolitical risks can also lead to concerns about future oil supply disruptions, which pushes up the value of holding oil contracts, thereby increasing prices.

The interplay between these opposing forces—the economic activity and risk channels—makes the impact on oil prices complex and situation-dependent. Therefore, oil prices remain highly volatile during the high geopolitical alerts.

Recent conflicts between Israel and Palestinian groups have introduced significant volatility to the oil market. As the conflict escalates, fears of a broader regional war have heightened, increasing the geopolitical risk premium. This premium reflects the added costs and risks associated with potential disruptions to oil supplies from the region, which is a key global oil supplier. As a result, oil prices have been supported at higher levels despite other factors that might have otherwise led to lower prices.

Similarly, the ongoing Russia-Ukraine conflict exerts upward pressure on oil prices. The conflict has affected European energy supplies and led to broader concerns about global oil supply stability. Russia’s recent military moves, including strengthening its border defenses, have further fueled these concerns. The potential for supply disruptions from one of the world’s largest oil producers has kept prices elevated, even as other market dynamics.

The geopolitical factor is also evident in the CBOE Volatility Index (VIX) chart below. This is also referred to as the “Fear Index,” which rises during periods of heightened uncertainty and fear in the financial markets. The spikes of 2008 crisis and the 2020 COVID-19 pandemic crisis are visible in the chart. Similarly, the index spiked in 2024, which reflects investors’ anxieties about the stability of the global economy, often driven by geopolitical risks, financial instability, or significant economic disruptions.

Historically, such spikes in the VIX have coincided with rising oil prices as investors seek safe-haven assets and anticipate potential supply disruptions due to geopolitical factors, such as conflicts in oil-producing regions. However, as the VIX begins to fall, it typically signals a reduction in market fear and a potential stabilization of the situation. For oil prices, this could mean that the initial panic-driven price surges may level off or even decrease as market participants reassess risks and geopolitical tensions show signs of easing.

Impact of U.S. Economic Data and Fed Policy on Oil Market Trends

The recent U.S. economic data alleviates fears of a recession in the world’s largest economy. The stronger-than-expected retail sales in July and a lower-than-expected increase in unemployment claims suggest that the U.S. economy is more resilient than previously thought. This positive economic outlook boosts investor confidence, increasing oil demand expectations and consequently pushing up prices in the short term.

The economic data also reinforced expectations that the U.S. Federal Reserve may cut interest rates soon. Lower interest rates typically stimulate economic activity by making borrowing cheaper, which can lead to increased consumer spending and industrial production. As a result, oil consumption tends to rise, further supporting higher oil prices.

The moderate increase in U.S. consumer prices in July suggests that inflation is under control, which could encourage the Fed to proceed with rate cuts. This expectation of stronger economic growth and higher oil demand contributes to the current upward momentum in oil prices.

The chart below shows the relationship between Fed interest rates and oil prices. In 2020, when interest rates were lowered, oil prices sharply increased during the COVID-19 crisis. As interest rates started to rise in 2022, oil prices corrected lower. As the U.S. Federal Reserve’s anticipated interest rate cuts aim to support the economy, the evolving geopolitical landscape and the economic trajectory of major oil-consuming nations like China will play critical roles in shaping the future direction of oil prices.

Global Supply and Demand Trends

In Q2 2024, global oil demand increased by 870,000 barrels per day (kb/d), although a contraction in China constrained growth. Demand is expected to rise by less than 1 million barrels per day (mb/d) in 2024 and 2025, a significant slowdown compared to last year’s robust 2.1 mb/d growth. This deceleration is due to the macroeconomic challenges and geopolitical factors discussed above, limiting the pace of demand expansion.

On the supply side, world oil production rose by 230 kb/d in July, reaching 103.4 mb/d, driven by a substantial increase from OPEC+ members that offset losses from non-OPEC+ producers. While non-OPEC+ production is projected to grow by 1.5 mb/d in 2024 and 2025, OPEC+ output may decline in 2024 but could rebound if voluntary production cuts remain in effect.

These supply and demand trends directly impact oil prices, which have exhibited significant volatility. Despite escalating geopolitical tensions in the Middle East, the recent drop in Brent crude futures by $6 per barrel in July highlights the influence of weak macroeconomic data on market sentiment. Even as oil supply remains tight in certain regions, such as the Atlantic Basin, and global inventories experience fluctuations, the overall market sentiment is driven by broader economic conditions.

Despite declining flat prices, the resilience in front-month time spreads suggests a complex interplay between supply constraints and demand uncertainties. As Brent crude hovers around $80 per barrel, the balance between global supply increases, particularly from non-OPEC+ countries, and muted demand growth will continue to be a key determinant of oil prices soon.

Oil Market Consolidation

The price dynamics can be understood using the monthly chart of Brent Crude Oil, discussed previously. It is observed that prices have been highly volatile within the red channel. The formation of a symmetrical triangle within the channel indicates that prices are compressing in a sideways market before the next strong move.

Previously, prices broke down from a symmetrical broadening wedge in August 2014 and traded lower. However, the bottom at $15.98 during the COVID-19 crisis in 2020 marked a reversal to the upside. Currently, price momentum is trading within the symmetrical broadening pattern, suggesting that prices are likely to remain within the $70 to $90 range before the next move, which will depend on the breakout patterns.

The chart below further clarifies this price momentum on the weekly chart and shows that the triangle formation has a slightly bearish bias, with the head and shoulders pattern and the double top formation highlighted by the blue arrows. This formation indicates that if prices break the triangle to the downside, oil prices may drop before the next move. Last week’s rebound from this triangle strengthens the view of consolidation in the oil market.

This price consolidation is also evident on the daily chart below, which shows that prices lack a clear direction and pattern in the short term. Therefore, it will likely remain within strong consolidation until the symmetrical triangle is broken.

Bottom Line

In conclusion, oil prices are highly volatile, influenced by a complex mix of geopolitical tensions, economic data, and global supply and demand dynamics. While geopolitical conflicts and uncertainties have driven the risk premium, supporting higher prices, the broader economic environment, including U.S. economic resilience and potential Federal Reserve rate cuts, adds further complexity.

Supply and demand trends, particularly the constrained growth in global demand and fluctuating oil inventories, also play a critical role in shaping price movements. As markets navigate these intertwined factors, the future direction of oil prices remains uncertain, dependent on geopolitical developments and economic conditions. The prices remain within a triangle formation between $92 and $72, and a break of either of these levels will define the next move in the oil market.