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Oil recovery and the state of the Middle East

On both sides of the Atlantic, there is a concerted attempt to get people to switch to electric vehicles and heating systems, undermining the longer-term demand prospects for fossil fuels.

Charles Stanley

in Features Fiduciary news


The Abraham agreement, or peace Treaty signed by the United Arab Emirates and Israel, is a success for US foreign policy. The bitter long-running disputes between Arab states supporting the Palestinians, and Israel impeded all but Egypt in 1979 and Jordan in 1994 until last week from signing peace Treaties with Israel. 

Israel claims it is defending its state against terrorist attacks, whilst the Palestinians complain that it is extending her territory through settlements and avoiding agreement on a two-state solution to the Israeli Palestinian conflict over the West Bank and related lands. This Agreement offers the Israeli concession to the Palestinians that it will not develop more settlements for the time being.  The aim of the Agreement is to use this pause or stop to have more directed talks towards finding a two-state, longer-term solution to the problem of contested territory. 

Some say the UAE agreed to this as it wants to buy F35s from the US and seeks help in its continuing dispute with Qatar. Whatever the mixed motives, it allows all concerned to make a suitable announcement, and to toughen their alliance against Iran.

US troops out

All presidents have had a wish to resolve this deep and long-running dispute by talks. Mr Trump has brought two different features to the table from his predecessors. He has made clear his wish to disengage the US military from the wars and civil disturbances of the Arab countries, removing US power from seeking to settle the political future of several troubled states. He has also delivered on his promise to make the US self-sufficient in oil and gas, so he does not need the trade or goodwill of any in the Middle East to keep the lights on and the planes flying.

In President Obama's last year in office, he authorised the dropping of 26,000 bombs. He committed to military action in Syria, Iraq, Afghanistan and Yemen, and authorised small action in Pakistan and Somalia. At peak during his Presidency, he had 99,000 troops in Afghanistan and 95,000 in Iraq – and intervened in Libya. Mr Trump came to office promising that "Great nations do not fight endless wars". He wanted to bring "our soldiers back". It was more of an arm wrestle with the military than he expected, but he did gradually disengage from direct conflict in Iraq, Afghanistan and other Middle Eastern countries. When he had to respond to the Syrian use of chemical weapons in 2018, he made sure the bombs unleashed were the minimum possible. He did continue with missions against ISIS, delaying his exit from some military activities.

The paradox of the Trump strategy lies with the oil market. Breaking the Middle East's hold over the US by greatly expanding US production, President Trump has also set in train more supply and lower prices for oil at a time when maintained US output requires higher prices. His strategy has relied on Opec taking cuts to their output to compensate for extra US production, to avoid a slump in prices.

With brinkmanship, Mr Trump pulled off the feat of expanding US production whilst not undermining oil prices too far until the virus struck. The immediate cessation of most flying, much surface transport using petrol and diesel, and some commercial and industrial fossil fuel use led to a sharp drop in demand for oil and a collapse in the oil price.

Opec, once again led by Saudi, agreed on production cuts with Russia after a brief price war. The USA did not wish to expressly join cartel action to cut output, but let it be known that US output too would adjust downwards to the demand and price situation in the market. It was sufficient to get a deal to prop the oil price, which promptly rallied from ultra-low levels.

Demand has slumped

According to the US Energy Information Administration, in the second quarter of 2020, oil output averaged 85 million barrels per day (bpd), down 15.8 million bpd on the previous year. By July it had risen to 93.4 million bpd.  US EIA anticipates it averaging around 93 million b/d this year, down on the 100m b/d plus seen in 2019. This will mainly reflect consumption changes. US gasoline, currently at $2.18 a gallon is forecast to fall to $2 by year-end, compared to $2.74 in July 2019, a useful reduction in inflation. The International Energy Agency also expects oil demand to be down around 8m b/d this year, with an increase of 5.3m b/d in 2021. They have recently become a little more pessimistic thanks to the delays in getting aviation back to anything like previous levels.

The Trump years have seen a large expansion of US oil and gas at the expense of Opec's share of the world market. Some Opec members inflicted pain upon themselves, reducing their shares dramatically. Venezuela, which was producing 2.5 million bpd as recently as 2016, now struggles to produce 400,000 bpd, such is the deterioration in the management of the fields, tankers, pipes and other production infrastructure. Iran, under the stress of heavy US sanctions, publishes output of 2 million bpd compared to the 4 million bpd it used to able to produce. Opec today accounts for little more than one-quarter of world oil output, and the US has leapfrogged Saudi Arabia to be the world's largest producer. Venezuela with the world's largest country reserves is an extraordinary story of government disaster.

The outlook for oil is for a gradual rebuilding of demand towards 2019 levels over the next eighteen months. This is likely to allow some further appreciation in the oil price. All the time aviation is depressed, demand will be weaker than before. Meanwhile, on both sides of the Atlantic, there is a concerted attempt to get people to switch to electric vehicles and heating systems, undermining the longer-term demand prospects for fossil fuels.

If Joe Biden wins the US Presidency, he wishes to cut both US output and US demand for oil. He will want to pursue peace talks in the Middle East. Overall the consensus of gentle rises in oil prices as recovery sets in, partially offset by long-term hostility to carbon-based energy, seems to be the best forecast of what might happen in a notoriously volatile commodity and region of the world.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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