What is pulling oil prices down?

Oil prices have dropped below $77 — more than 30 percent lower than the five-year peak of $112, which was only five months ago.

The main parameters that affect oil prices are the outlook of global economic growth, stability in oil-rich regions (the Middle East, Russia) and the demand/supply equilibrium.

Other than the fact that the American economy is showing reasonable signs of recovery, the rest of the world is still in a very slow recovery. In fact, the end of quantitative easing and the expected rate hike by the US Fed in six months’ time have caused major problems for emerging markets, while the eurozone and Japan aren’t growing at all and China’s economic growth has slowed down to 5 percent. Oil-rich regions are also in bad shape due to the failure of the Arab Spring, the emergence of the Islamic State of Iraq and the Levant (ISIL) and the Ukrainian civil war. All these point to more stable if not upward oil prices; yet we have seen probably the fastest drop in oil prices in decades.

We have also recently started to hear that the shale gas/oil boom in the US is the main trigger for oil prices to drop in a dramatic fashion. OPEC countries are supposedly allowing oil prices to drop to a level where shale gas will become an unsustainable alternative due to the high costs involved with such deep drilling. BHP, the world’s second-largest mining company, has already announced that it will offload its shale gas investments in the US. Few people will find this argument convincing as the world oil market is too big to be affected so much and for the demand for oil to drop to historic lows.

In recent comments, other analysts have said that the US is using shale gas and increasing its oil output along with the Saudis to reduce oil prices. This will have an immediate economic implication for Russia, which relies on oil prices being above $100 per barrel to keep its economy intact. Therefore the Obama administration is actually using similar economic tools to those which worked against Iran to punish Russia for its Ukraine policies. The way oil prices are going down will definitely test Putin and cause the Russian people to consider if it is worth risking an economic crisis to have control over Ukrainian politics.

If this analysis is correct, then we might also see a sudden increase in oil prices if the US and Russia reach a deal on Ukraine. Under pressure, the Turkish lira and Turkish bond yields started to enjoy the historically low oil prices due to the expected positive effect on Turkey’s current account deficit (CAD) and its reliance on foreign investments into the country. If oil prices stay at current levels, the CAD to GDP may drop to 5 percent — a deficit that is more sustainable. However, a normalization of oil prices will then have the opposite effect on the Turkish economy due to Turkey’s reliance on oil imports and its large CAD. It may also pressure the Turkish lira against the dollar as buying US dollars may seem more attractive nowadays.

The oil and gold markets are usually too big to be manipulated by even very large funds or central banks. It would be very wise for small investors to stay away from speculating on these commodities as well as currencies if one doesn’t want to receive very nasty financial losses. Lately, the volatility we see for currencies and commodities is nothing less than stock market volatilities. Since the 2008 global financial crisis, most investment assets are being managed differently, which tells us to reassess our risk management when considering investments in property (especially commercial), treasury bonds (see Greece and the PIGS, etc.), commodities and currencies. They all tended to be deemed low risk investments but have now become as high risk as any shares in the stock market.

We are also experiencing unexpected trends such as the recent oil price changes, which makes it very hard to take calculated risks by making conventional analyses of current markets.

*Sel├žuk Aziz is a fund management expert

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